ARCHIVED - Transcript - Hull, QC - 2001/10/15
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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 15, 2001||le 15 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
officielles, les procès-verbaux pour le Conseil seront
bilingues en ce qui a trait à la page couverture, la liste des
membres et du personnel du CRTC participant à l'audience
publique ainsi que la table des matières.
Toutefois, la publication susmentionnée est un compte rendu
textuel des délibérations et, en tant que tel, est enregistrée
et transcrite dans l'une ou l'autre des deux langues
officielles, compte tenu de la langue utilisée par le
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 15, 2001||le 15 octobre 2001|
TABLE OF CONTENTS / TABLE DES MATIÈRES
PAGE / PARA NO.
|SWORN: MR. JOHN MATWICHUK||2561 / 16101|
|SWORN: Mr. JOHN TODD||2561 / 16101|
|SWORN: DR. TREVOR ROYCROFT||2561 / 16101|
|EXAMINATION BY / INTERROGATOIRE PAR|
ARC et al, BCOAPO et al, Consumers Association of Manitoba, Manitoba Society of Seniors, City of Calgary
|2561 / 16104|
|2565 / 16145|
|2634 / 16608|
|2681 / 16962|
|2697 / 17053|
|AFFIRMED: THERESA MUIR||2728 / 17206|
|AFFIRMED: JOHN T. McLENNAN||2728 / 17206|
|AFFIRMED: DAVID A. LAZZARATO||2728 / 17206|
|2728 / 17208|
|2731 / 17224|
LIST OF EXHIBITS / PIÈCES JUSTICATIVES
EXHIBIT NO. DESCRIPTION PAGE NO. / PARA NO.
THE COMPANIES 43 Correction to The 2556 / 16078
Companies Exhibit No. 4,
which should have been
The Companies' response
to undertaking requested
by Commissioner McKendry,
Volume 7, paragraph 11359
THE COMPANIES 45 Response to Question No. 1 2557 / 16079
of CRTC Exhibit No. 6
ALIANT TELECOM 1 Aliant response to undertaking 2557 / 16080
requested by Commission Counsel,
Ms Moore, transcript reference,
Volume 5, paragraph 9066
ALIANT TELECOM 2 Response to undertaking requested 2557 / 16081
by Commission Counsel, Ms Moore,
transcript reference, Volume 5,
ALIANT TELECOM 3 Response to undertaking requested 2558 / 16082
by Commission Counsel, Ms Moore,
transcript reference, Volume 5,
ALIANT TELECOM 4 Response to undertaking requested 2558 / 16083
by Commission Counsel, Ms Moore,
transcript reference, Volume 5,
ALIANT TELECOM 5 Response to undertaking requested 2558 / 16084
by Commission Counsel, Ms Moore,
transcript reference, Volume 5,
ARC et Al 12 CV of Mr. John Todd 2631 / 16591
ARC et al 13 CV of Mr. Greg Matwichuk 2631 / 16592
ARC et al 14 CV of Dr. Trevor Roycroft 2631 / 16593
THE COMPANIES 46 May 11, 20001, Illinois Bell 2631 / 16594
Telephone Company Order 98-0252
LIST OF EXHIBITS / PIÈCES JUSTICATIVES
EXHIBIT NO. DESCRIPTION PAGE NO. / PARA NO.
THE COMPANIES 47 Texas Office of Public Utility 2632 / 16595
THE COMPANIES 48 Dr. Roycroft's TFP Model with 2632 / 16596
Growth in Local Calls Per Access
THE COMPANIES 49 Estimating the Effects of 2632 / 16597
Diffusion of Technological
Innovations in Telecommunications
THE COMPANIES 50 Dr. Roycroft's TFP Model With 2632 / 16598
a Time Trend
TELUS 12 TELUS response to Undertaking 2679 / 16950
requested by BCOAPO. Transcript
reference, Volume 8, paragraph 12771
TELUS 13 Response to Undertaking requested 2679 / 16951
by GT Group Telecom. Transcript
reference, Volume 8, paragraph 13410
TELUS 14 Response to Undertaking requested 2680 / 16952
by Commission Counsel Ms Moore.
Transcript reference Volume 8,
TELUS 15 Response to Undertaking requested 2680 / 16953
by BCOAPO. Transcript reference
Volume 9, paragraph 14697
TELUS 16 N-MAX Information Summary, 2680 / 16954
CRTC 35 CRTC Undertaking for The 2680 / 16956
Companies regarding X factor
CRTC 36 Undertaking for TELUS regarding 2681 / 16957
forecast X factor
THE COMPANIES The Companies response to 2905 / 18531
undertaking requested by ARC et al,
transcript reference, Volume 3,
paragraph 4272 and Commissioner
Cram's transcript reference,
Volume 4, paragraph 6872LIST OF EXHIBITS / PIÈCES JUSTICATIVES
EXHIBIT NO. DESCRIPTION PAGE NO. / PARA NO.
THE COMPANIES 52 The Companies response to 2906 / 18532
CRTC Exhibit No. 30
THE COMPANIES 53 Response to undertaking requested 2906 / 18533
by Commission Counsel, Ms Moore,
transcript reference Volume 2,
THE COMPANIES 54 Short form prospectus 2906 / 18534
THE COMPANIES 55 Bell residence basic local versus 2906 / 18535
AT&T using unbundled loops
THE COMPANIES 56 Resale of hypothetical ILEC 2907 / 18536
retail service under AT&T proposal
THE COMPANIES 57 Bell Centrex voice local versus 2907 / 18537
THE COMPANIES 58 AT&T Canada and BCE historical 2907 / 18538
ALIANT TELECOM 6 Aliant response to Question 2907 / 18539
No. 1 of CRTC Exhibit No. 4
ALIANT TELECOM 7 Aliant response to Question 2907 / 18540
No. 2 of CRTC Exhibit No. 4
ALIANT TELECOM 8 Aliant response to Question 2908 / 18541
No. 3 of CRTC Exhibit No. 4
ALIANT TELECOM 9 Aliant response to Question 2908 / 18542
No. 4 of CRTC Exhibit No. 4
Hull, Quebec / Hull (Québec)
--- Upon resuming on Monday, October 15, 2001
at 0830 / L'audience reprend le lundi
15 octobre 2001 à 0830
16074 THE CHAIRPERSON: Order, please, ladies and gentlemen.
16075 Before we turn to the next panel, Mr. Secretary, I understand you have a number of exhibits to enter.
16076 MR. SPENCER: Thank you, Mr. Chairman.
16077 I have seven documents.
16078 The first is a correction to The Companies Exhibit 43, which should have been The Companies response to undertaking requested by Commissioner McKendry, transcript reference, Volume 7, paragraph 11359. This will be introduced as The Companies Exhibit No. 43.
EXHIBIT NO. THE COMPANIES 43: Correction to The Companies Exhibit No. 43, which should have been The Companies' response to undertaking requested by Commissioner McKendry, transcript reference, Volume 7, paragraph 11359
16079 MR. SPENCER: We also have a response to Question No. 1 of CRTC Exhibit No. 6, which will be The Companies Exhibit No. 45.
EXHIBIT NO. THE COMPANIES 45: Response to Question No. 1 of CRTC Exhibit No. 6
16080 MR. SPENCER: We have Aliant response to undertaking requested by the Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9066, which will be Aliant Telecom Exhibit No. 1.
EXHIBIT NO. ALIANT TELECOM 1: Aliant response to undertaking requested by Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9066
16081 MR. SPENCER: A response to undertaking requested by Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9009, will be Aliant Telecom Exhibit No. 2.
EXHIBIT NO. ALIANT TELECOM 2: Response to undertaking requested by Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9009
16082 MR. SPENCER: Response to undertaking requested by Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9020, will be Aliant Telecom Exhibit No. 3.
EXHIBIT NO. ALIANT TELECOM 3: Response to undertaking requested by Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9020
16083 MR. SPENCER: Response to undertaking requested by Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9047, will be Aliant Telecom Exhibit No. 4.
EXHIBIT NO. ALIANT TELECOM 4: Response to undertaking requested by Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9047
16084 MR. SPENCER: The last one, a response to undertaking requested by Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9042, will be Aliant Telecom Exhibit No. 5.
EXHIBIT NO. ALIANT TELECOM 5: Response to undertaking requested by Commission Counsel, Ms Moore, transcript reference, Volume 5, paragraph 9042
16085 MR. SPENCER: Thank you
16086 THE CHAIRPERSON: Thank you, Mr. Secretary.
16087 So before we turn to the next panel, are there any preliminary matters anyone wishes to bring to the attention of the chair?
16088 Ms Lawson.
16089 MS LAWSON: Thank you, Mr. Chairman.
16090 Just a minor matter, in respect of oral argument. A number of parties, as you know, are from out of town, in particular the west -- and I'm speaking here on behalf of my colleagues in Alberta and Manitoba -- who may find it difficult to return here to make oral argument and they are wondering if there might be provision for the audio feed in the same way that the Commission did for the public comments on day one of the hearing.
16091 THE CHAIRPERSON: Actually, one of your colleagues from out west had already mentioned that last week. Frankly, we hadn't made a final decision on that, so we will get that finalized this week.
16092 MS LAWSON: Thank you.
16093 THE CHAIRPERSON: Anything else?
16094 Okay, then, we will turn to the next panel, representing ARC et al.
16095 Ms Lawson.
16096 MS LAWSON: Thank you, Mr. Chairman.
16097 On behalf of ARC et al, BCOAPO et al, the Consumers Association of Manitoba and Manitoba Society of Seniors and the City of Calgary, we are presenting a panel this morning, beginning from, closest to you, Mr. Greg Matwichuk, Mr. John Todd, in the middle.
16098 Mr. Todd and Mr. Matwichuk are responsible jointly for the written evidence entitled "The Second Generation Price Cap Regime" and related interrog responses. Their curriculum vitae are appended to that evidence.
16099 Then furthest away from you is Dr. Trevor Roycroft, who is responsible for the written evidence in his name and the interrog responses related to that. His curriculum vitae is also appended to his evidence.
16100 I think the witnesses could be sworn in now.
16101 MR. SPENCER: Thank you.
SWORN: MR. JOHN MATWICHUK
SWORN: Mr. JOHN TODD
SWORN: DR. TREVOR ROYCROFT
16102 MR. SPENCER: Thank you.
16103 MS LAWSON: Thank you, Mr. Chairman.
EXAMINATION / INTERROGATOIRE
16104 MS LAWSON: Gentlemen, can you please confirm that your experience and qualifications, as stated in the curriculum vitae appended to your pre-filed testimony are accurate.
16105 Mr. Matwichuk?
16106 MR. MATWICHUK: Yes, it is.
16107 MR. TODD: Yes, it is.
16108 DR. ROYCROFT: Yes, it is.
16109 MS LAWSON: Thank you.
16110 Messrs. Todd and Matwichuk, can you please confirm that the submission entitled, "The Second Generation Price Cap Regime" and the related interrogatory responses were prepared by you or under your direction?
16111 MR. TODD: Yes, they were.
16112 MR. MATWICHUK: Yes, they were.
16113 MS LAWSON: Is this evidence and those interrog responses correct, to the best of your knowledge and belief?
16114 MR. TODD: Yes, they are.
16115 MR. MATWICHUK: Yes, they are, Ms Lawson.
16116 MS LAWSON: Have there been any developments since the filing of that evidence and those responses that would affect your testimony, or are there any corrections that you would like to make at this time?
16117 MR. MATWICHUK: Ms Lawson, there is one correction that I would like to draw the attention of the Commission to. It is paragraph 52.
16118 In that paragraph, on the third line the third word states "4" and it should be "2". It is a comparison of the two largest telephone companies that own or control the subscriber lines in the country. It is a comparison between the 1994 and 1995 era versus the current era.
16119 To make the comparison appropriate, it should be both -- both sentences should be "2". So it was simply a misprint indicating "4", previously.
16120 The percentages of 87 per cent and 96 per cent both reflect "2".
16121 Thank you.
16122 MS LAWSON: Is that it?
16123 MR. MATWICHUK: That's the only correction.
16124 MS LAWSON: Thank you.
16125 Dr. Roycroft, was the submission entitled, "Prepared Testimony of Trevor Roycroft" and the related interrog responses prepared by you or under your direction?
16126 DR. ROYCROFT: Yes, they were.
16127 MS LAWSON: Is this evidence and those interrogatory responses correct, to the best of your knowledge and belief?
16128 DR. ROYCROFT: Yes, it is.
16129 MS LAWSON: Have there been any developments since the filing of that evidence and those responses that would affect your testimony or are there any corrections that you would like to make at this time?
16130 DR. ROYCROFT: There has been a development that I would have included in my testimony, relating to Appellate Court rulings on the FCC's calls proposal. I discuss that on page 12, in paragraph 23.
16131 The development that has occurred, on September 10th of this year, was that an Appellate Court remanded portions of the FCC's calls order specifically related to the calculation of the Universal Service Fund component and also with regard to the calculation of the offset that is included in the calls plan.
16132 That is the only change that has occurred that I would have discussed in my testimony had it occurred prior to the filing date.
16133 There was one typographical error of substance that I wanted to correct, and that occurs in Attachment TRR-2, on page 21.
16134 On page 21 there is a table, Table 11, and there is a typographical error in the row that is in a section of the table called "Model 2: Estimated Coefficient for SPC*FPC1". The estimated coefficient shown there is ".402". That is a typographical error. It should be ".0402".
16135 That is the only correction.
16136 MS LAWSON: Thank you very much.
16137 Mr. Chairman, the witnesses are ready to be cross-examined.
16138 THE CHAIRPERSON: Thank you, Ms Lawson.
16139 Good morning, gentlemen. Welcome to our proceeding.
16140 DR. ROYCROFT: Good morning.
16141 THE CHAIRPERSON: We will turn now to the first party to cross-examine this panel, and that is The Companies.
16142 Mr. Henry.
16143 MR. HENRY: Thank you, Mr. Chairman.
16144 I'm assisted this morning by, a familiar face by now, Dr. Hariton.
EXAMINATION / INTERROGATOIRE
16145 MR. HENRY: Gentlemen, the part of your evidence that I'm interested in is the part that deals with the effect of price cap regulation on company productivity. So my questions this morning will be directed at Dr. Roycroft primarily.
16146 Dr. Roycroft, as I understand it, you performed an analysis that attempted to measure the impact of price cap regulation on regulated company productivity. Is that correct?
16147 DR. ROYCROFT: That is correct, for corporations in the United States.
16148 MR. HENRY: Right.
16149 You reported that in Attachment TRR-2 to your evidence?
16150 DR. ROYCROFT: That is correct.
16151 MR. HENRY: This study, as I understand it, examines the effect on total factor productivity, TFP, of different regulatory schemes for the 13 Bell operating companies you studied?
16152 DR. ROYCROFT: Yes, the effect of the regulatory regimes controlling for other factors that may influence total factor productivity growth.
16153 MR. HENRY: Right.
16154 You conclude that these results show that the introduction of various combinations of state and federal price cap plans and state incentive regulation lead to increases in TFP growth over that experienced under rate of return regulations. Is that correct?
16155 DR. ROYCROFT: That is correct.
16156 MR. HENRY: You also say that the results show that the introduction of local exchange competition through the Telecommunications Act of 1996 has led to lower TFP growth rates for these companies?
16157 DR. ROYCROFT: The examination that I do allows me to control or hold factors constant. The result is to focus on specific influences that are having an impact on the overall observed total factor productivity growth. So per my results there is evidence that the introduction of the Telecommunications Act of 1996 had led to downward pressure on total factor productivity growth, while regulatory change and other factors had led to upward pressure.
16158 The overall observed trend, just based on averages, shows an increase over time in total factor productivity growth.
16159 MR. HENRY: Right.
16160 Now, the results of this statistical analysis I think are set out in Table 9 of page 17 of the Attachment TRR-2. I wonder if you could turn to that, please. It is Attachment TRR-2 to Dr. Roycroft's evidence, page 17, Table 9.
16161 DR. ROYCROFT: I'm there.
16162 MR. HENRY: Just wait for a minute for the room to catch up.
16163 Now, I approach this with some trepidation, but I'm going to try to see if I have an understanding of this table.
16164 As I understand it, the variable names listed under column 2 lists all the explanatory variables in your model?
16165 DR. ROYCROFT: That is correct.
16166 MR. HENRY: As I understand it, an explanatory variable is something that explains the dependent variable, and in this case the dependent variable is the TFP results for each of the 13 companies you studied?
16167 DR. ROYCROFT: That is correct.
16168 MR. HENRY: Now, as I understand it, your model uses TFP measurements for the 13 state level Bell operating companies over the period 1986 to 1998. Is that correct?
16169 DR. ROYCROFT: That is correct.
16170 MR. HENRY: What you are attempting to do is see the impact on those TFP results of the 13 variables, explanatory variables, that we just looked at on that table. Is that correct?
16171 DR. ROYCROFT: Correct.
16172 MR. HENRY: Don't put that table away, we will be coming back to it.
16173 But now that I understand the purpose of your Table 9-1 I want to look at two areas. I want to look first at the TFP results that you used and how you developed them, and then we will come back and discuss the results of the explanatory variables in your model, if you don't mind.
16174 Turning to the TFP results, as I understand it, you started with TFP results that you estimated for each of the 13 Bell operating companies?
16175 DR. ROYCROFT: That is correct.
16176 MR. HENRY: You have used the methodology based on the one used by the FCC staff?
16177 DR. ROYCROFT: Yes. The FCC staff published a TFP model in 1997 with the 1997 FCC price cap resubscription that allowed for the calculation of TFP growth. The FCC's model was an aggregate approach, in that they aggregated data for all RBOCs nationwide and I applied the model on a state-by-state basis, where the data was available.
16178 Reporting requirements in the United States are inconsistent, which do not, therefore, allow for every state to be examined, but the 13 states that I did examine where the ones where the data was available.
16179 MR. HENRY: Okay. The FCC did this for the purpose of coming up with a single productivity factor that they could then apply to all the local exchange carriers, subject to their price cap plan?
16180 DR. ROYCROFT: Correct. They utilized the model as a component of the development of the overall X factor to be used for the interstate operations that are governed by the FCC.
16181 MR. HENRY: By attempting to disaggregate the data for each of the 13 companies, you could then attempt to measure separately for each company the effects on each of the companies separately?
16182 DR. ROYCROFT: Correct.
16183 MR. HENRY: One of the reasons for doing that is because all of those companies were subject to differing combinations of regulatory schemes at different points in time?
16184 DR. ROYCROFT: Correct.
16185 MR. HENRY: Now can I ask you, where did you obtain the state level data needed to estimate the TFP for each company?
16186 DR. ROYCROFT: The state level data was available from sources that are published by the FCC, which include the ARMIS databases. Then, in addition, there was other information that was contained in the precursors to ARMIS FCC reports that, at the time were not -- the ARMIS system is an automated system that ultimately publishes electronically the information.
16187 Previous FCC reports were also used to draw information for especially some of the earlier years in the study and there were some additional FCC sources that were utilized for specific variables. All of the information that was drawn was publicly available information that was produced -- reported by the companies to the Federal Communications Commission.
16188 MR. HENRY: The reason you didn't choose the other 57 states is because state level information wasn't available, it was only available at the RBOC level?
16189 DR. ROYCROFT: The other 37 states do not report in the same way that the 13 states contained in my study do. That is an artifact of the structure of the Bell system and the reporting practices that emerged after the divestiture.
16190 As it turns out, prior to divestiture these 13 companies were reporting on an individual state basis. They continued to do so after divestiture. The remaining states report information only on a holding company basis, which aggregates data beyond the state level.
16191 MR. HENRY: If the FCC only needs the data at the holding-company level, why do these remaining 13 states continue to report state level data?
16192 DR. ROYCROFT: I think it's just an artifact or tradition. They have not changed that reporting requirement, even to this day.
16193 MR. HENRY: Do you know what level of outside scrutiny there is of the state level data that is provided for the 13 states in your study? Are they audited, for example?
16194 DR. ROYCROFT: The companies are required to report accurate information. My experience has been that the companies periodically correct the information that has been filed. There is no auditing process that I'm aware of with regard to the values that are reported.
16195 MR. HENRY: Because the FCC really only needs it at the RBOC level, they wouldn't need to scrutinize those state level --
16196 DR. ROYCROFT: In fact, with regard to the RBOCs that are studied here, Ameritech, Bell Atlantic and Pacific Bell, the only data that is available or that was available at the time of the study for those RBOCs was the individual state level data. If the FCC was interested in a particular RBOC they would need to aggregate that data for themselves.
16197 Furthermore, the FCC may have interest in the state level data. To say that they are only interested in the RBOC level is not, in my view, accurate. They may have interest in looking at state level data as well.
16198 MR. HENRY: But for this purpose, they only needed it at the RBOC level?
16199 DR. ROYCROFT: For the purpose of --
16200 MR. HENRY: Of calculating the TFP, the X factor for their price cap plan?
16201 DR. ROYCROFT: Right. They went a step further in that they aggregated the data for all of the RBOCs when they performed their TFP study.
16202 MR. HENRY: Right.
16203 Now, would you agree with me that many functions are performed at the regional holding company level in the U.S., back office functions, and so on?
16204 DR. ROYCROFT: Yes.
16205 MR. HENRY: Have you reviewed how the FCC allocates the costs of those functions among the state level operating companies?
16206 DR. ROYCROFT: I have reviewed that at some point. I don't recall the exact details at this time.
16207 MR. HENRY: Could the nature of this allocation affect the TFP results reported by the states or that you calculate for the states?
16208 DR. ROYCROFT: It could have some impact.
16209 MR. HENRY: Now, as I understand it, any TFP model looks at outputs and inputs of the company under study. Correct?
16210 DR. ROYCROFT: Correct.
16211 MR. HENRY: As I understand it, in its TFP methodology the FCC measures three outputs. We will deal with the output side first. Local output, intrastate toll input and interstate access output. Is that correct?
16212 DR. ROYCROFT: That's correct.
16213 MR. HENRY: I want to focus for just a moment on the local output.
16214 Now, I noticed the FCC measured local output as the number of local calls. I presume that is what you did because you were disaggregating their results?
16215 DR. ROYCROFT: That is correct. I applied the same modelling approach that they did with regard to local output.
16216 MR. HENRY: Would you agree with me that the bulk of the costs of local service are non-usage sensitive?
16217 DR. ROYCROFT: Of making local calls?
16218 MR. HENRY: Right.
16219 DR. ROYCROFT: No.
16220 MR. HENRY: Wouldn't the local loop represent the largest portion of the costs?
16221 DR. ROYCROFT: That requires that you assume that there is cost causality with regard to local exchange service in the local loop, and that is an economic issue that I don't agree with.
16222 I believe the local loop is a shared input that provides a wide variety of services. With regard to local calling, the direct costs of local calling would be costs of switching and transport associated with originating and completing local calls.
16223 MR. HENRY: You don't agree that the local loop is non-usage sensitive? The loop itself?
16224 DR. ROYCROFT: I certainly agree that proposition, but you indicated that the local loop was uniquely associated with providing local calls.
16225 MR. HENRY: No, I don't think I meant to imply that it's uniquely associated with that.
16226 But it is non-usage sensitive and it represents the bulk of the costs of providing local service?
16227 DR. ROYCROFT: I can agree with you that the local loop is a non-traffic sensitive cost. With regard to the issue of cost causality, in the United States at least, there are practices of treating the local loop in a way that local service alone is not responsible for recovering the full cost of the local loop.
16228 MR. HENRY: That is partly because of the state federal jurisdiction? There are separations done for that purpose?
16229 DR. ROYCROFT: There is recovery associated with interstate and state jurisdiction. In some states as well, with the advent of DSL services, there have been charges placed under the line sharing arrangement which require payment be made for use of the high frequency portion of the local loop.
16230 MR. HENRY: Are you aware that in Canada this Commission has found that the local loop represents the vast majority of primary exchange costs?
16231 DR. ROYCROFT: I'm aware of that position, yes.
16232 MR. HENRY: Now, would you agree that if the majority of costs do not vary with usage, it might be more accurate to measure local output by the number of access lines, rather than the number of local calls?
16233 DR. ROYCROFT: That could be another approach to measure output.
16234 You could also consider, for example, dial equipment minutes as an alternative. A local call has a duration and the duration of local calls can vary.
16235 It has been observed, especially with the advent of the Internet, that the number of minutes that a customer spends on a local call in the United States has increased over time.
16236 MR. HENRY: Okay. I wonder if you could turn to the document I distributed to you yesterday -- and hopefully it's around the room. It is an Illinois document -- oh, oh, here we go -- an Illinois document that on the top left corner it says: "Illinois Bell Telephone Company" and it says "May 22, 2001".
16237 DR. ROYCROFT: Yes, I have that document.
16238 MR. HENRY: Okay. Now, as I understand it, this is a hearing examiner's recommended proposed order to the Illinois Commerce Commission in a proceeding dealing with price cap regulation at the state level.
16239 I recognize that the -- or my understanding at least is that the Commission itself has not yet rendered its decision and this is a hearing examiner's report. Do you know if that is true.
16240 DR. ROYCROFT: To the best of my knowledge that is true.
16241 MR. HENRY: Could you turn to page 91, please?
16242 On page 91, the bottom half, the hearing examiner is characterizing the staff's response to the FCC's productivity methodology. Under the heading "Staff's Response" the second paragraph says as follows:
"Similarly, staff contends that the study used by the FCC to arrive at its 6.5 per cent X factor is flawed. Staff argues that it produces inaccurate output growth, input price growth and productivity growth estimates.
Specifically, staff cites the following flaws with the FCC study:
(1) proxying local output by local calls only when in fact local output consists of many services, including lines and vertical services which grow at different rates than minutes;
(2) excluding miscellaneous revenues from the output measure; and
(3) inappropriately computing capital input prices based on realized rather than expected rates of return." (As read)
16243 So you agree that at least the staff of the Illinois Commission has criticized it on the basis that I was suggesting to you, this local output measure?
16244 DR. ROYCROFT: Yes. In fact the FCC itself has acknowledged the local output issue as well the capital input price issue in November of 1999, releasing FCC Order 99-345, which was a further notice of proposed rule-making in their price cap performance review docket.
16245 In that further notice of proposed rule-making, the Commission was responding to an Appellate Court remand on the 6.5 per cent productivity offset.
16246 The FCC staff, working in response to parties that were participating in that proceeding, responded to a number of perceived flaws in the original FCC model. Those flaws that the FCC staff addressed in FCC Order 99-345 included the local output issue and the capital input price issue, as well as some other more minor points that the parties had raised with regard to the total factor productivity calculation.
16247 The FCC staff made corrections to its model and published them as part of this order. The end result was to slightly increase the total factor productivity estimate over what the previous model had produced.
16248 I became aware of this revision to the model shortly after submitting the article, that is attached to my testimony as Attachment TRR-2, for publication.
16249 As a researcher I was not particularly concerned about the changes that the FCC had made for a couple of reasons.
16250 One reason was that the difference that the corrections to the FCC's model resulted in were quite small.
16251 Secondly, the impact on my results was to make my results essentially more conservative, from the standpoint of the revisions that the FCC staff made when making these corrections led to an increase in total factor productivity.
16252 Furthermore, the problem with the FCC's model was a systematic problem and, as a result, when using the data produced by the FCC staff model, the impact on my results was simply not present because my analysis is tracking the change in total factor productivity growth.
16253 To use an analogy or point of comparison that might help make sense, my statistical analysis is focusing on what happens when we move from rate of return regulation to alternative regulation plans. It is looking at the change in total factor productivity growth.
16254 Suppose that a police officer has a radar gun that is biased systematically, that it always reports information that is five miles per hour faster than the true speed of a vehicle, that radar gun will give you a biased estimate of the speed at which a vehicle is moving, but it would provide an accurate estimate of any acceleration of that vehicle. So if the vehicle was moving from 55 to 65 miles per hour, the acceleration would be accurately reported at 10 miles an hour, even though the beginning and end points were slightly in error due to the bias in the radar gun.
16255 Similarly with the total factor productivity contained in my model, the approach is to examine the acceleration, how much improvement there has been in total factor productivity results. As any biased contained in the FCC's model is systematic, that increase in total factor productivity will continue to be accurately reported.
16256 MR. HENRY: Even if that were true, at the total level of aggregation, if the FCC did it, it doesn't follow, does it, that the change would be identical for each company in your study?
16257 DR. ROYCROFT: Which change?
16258 MR. HENRY: The systematic bias could vary from company to company. It is not going to be exactly the same, is it?
16259 DR. ROYCROFT: There could be variations, but I would not expect them to be significant variations.
16260 MR. HENRY: Do you have any evidence that they are different?
16261 DR. ROYCROFT: I don't have any evidence that they are different and I don't have any evidence that they are not the same.
16262 MR. HENRY: But you are trying to isolate 13 different companies and measure the differences and the effect of the regulatory regimes and you are using aggregated data that may have a systematic bias in it.
16263 DR. ROYCROFT: The data does not have a bias in it.
16264 MR. HENRY: You said at the overall level it could have, but at the -- I'm saying at the individual company level you can't postulate that it would be the same bias as it would at the aggregate level.
16265 DR. ROYCROFT: The approach that I take, by pooling the information on the 13 companies from the three RBOCs essentially is an analysis that is based on state level variation, but ultimately has a -- as it works from a common pool, puts back in some of the aggregation to the analysis.
16266 I don't look at each individual state one at a time, but rather as a pooled group of companies that has certain advantages from a statistical standpoint in that it increases the overall number of observations and gives you a more powerful statistical predictor.
16267 MR. HENRY: Do the companies you study produce any other local service apart from basic exchange service? Things like options and features, local private lines, local data, local digital services?
16268 DR. ROYCROFT: Yes, they do.
16269 MR. HENRY: Would you agree that these other services grow at different rates for different companies in your sample, or certainly could?
16270 DR. ROYCROFT: I'm sorry, the hum drowned you out. I couldn't quite pick that up.
16271 MR. HENRY: It is annoying, isn't it.
16272 THE CHAIRPERSON: This is not deliberate, Dr. Roycroft. We have had this from the air conditioning system. We have had it several days during this and the hearing secretary has asked maintenance to see if we can't get it resolved. It usually only takes a few minutes.
16273 MR. HENRY: Would you agree that the companies you have studied produced other local services, such as options and features, local private lines, local data and local digital services?
16274 DR. ROYCROFT: Yes, they do.
16275 MR. HENRY: And that these services might grow at different rates for different companies in the sample?
16276 DR. ROYCROFT: Yes, they could.
16277 MR. HENRY: Did you do anything to account for different growth rates in those services?
16278 DR. ROYCROFT: No, I didn't, but I do recognize that as a general proposition my knowledge of those types of services leads me to conclude that those services were growing at fairly rapid rates, most likely more rapid than local calls and, therefore, the rapid growth that was excluded would essentially understate the total factor productivity.
16279 MR. HENRY: Would you at least agree that if you were to include these other local outputs the resulting TFP growth rates could change from company to company?
16280 DR. ROYCROFT: There could be changes.
16281 MR. HENRY: Are you aware that Bell Canada's TFP studies include physical output measures for things like options and features of local channels?
16282 DR. ROYCROFT: Yes.
16283 MR. HENRY: Now, we have talked a bit about the output side of the TFP estimation model and I now want to turn to the input side.
16284 COMMISSIONER LANGFORD: Excuse me, Mr. Henry. It is really quite bad at this side, so if you could speak up just a little more I would be grateful.
16285 MR. HENRY: Okay. I will do my best.
16286 COMMISSIONER LANGFORD: Thank you very much.
16287 THE CHAIRPERSON: Commission Langford, if you use the earphone --
16288 COMMISSIONER LANGFORD: Oh, good idea. We will go electronic here, if you can just give us a second.
16289 THE CHAIRPERSON: Sure.
16290 MR. HENRY: Okay, let's try this.
16291 We have talked for a moment about the output side of the TFP estimation model and I now want to turn to the input side for a moment.
16292 I understand you used three categories of input: labour, materials and capital.
16293 DR. ROYCROFT: That is correct.
16294 MR. HENRY: You measured labour by the number of employees?
16295 DR. ROYCROFT: That is correct.
16296 MR. HENRY: Some of these employees would be involved in installing equipment, laying local loops and connecting customers, things like that?
16297 DR. ROYCROFT: Yes.
16298 MR. HENRY: As I understand it, both in the U.S. and Canada a certain amount of the labour costs associated with these employees are capitalized on the regulated companies' books?
16299 DR. ROYCROFT: That is correct.
16300 MR. HENRY: Therefore a portion of the labour cost is included in capital expenditures and in plant and service?
16301 DR. ROYCROFT: Yes.
16302 MR. HENRY: When you measure capital and labour as two separate outputs, there is double counting. Correct?
16303 DR. ROYCROFT: The initial FCC approach was to calculate capital as a residual value -- capital input prices. That was corrected with their 1999 order. Even with that correction I believe there could continue to be some double counting, as you suggest.
16304 MR. HENRY: Just so I'm clear, did you follow the 1999 FCC methodology or the earlier?
16305 DR. ROYCROFT: The earlier methodology.
16306 MR. HENRY: So the correction wouldn't be in your results?
16307 DR. ROYCROFT: That is correct.
16308 MR. HENRY: Are you aware that in Bell Canada's TFP studies the capitalized labour is separated out?
16309 DR. ROYCROFT: I was not aware of that specific point.
16310 MR. HENRY: Now, let's turn to capital for a moment.
16311 As I understand it, the FCC uses a single category of capital and it aggregates all classes of plant into one. They say they do this because it is sufficient for their purposes for getting a national number. Is that correct?
16312 DR. ROYCROFT: That is correct.
16313 MR. HENRY: Did you check to see whether a single category rather than several classes of plant would affect your results?
16314 DR. ROYCROFT: No.
16315 MR. HENRY: Would you agree telephone plants includes both long-lived structures, like buildings and support structures, as well as shorter-lived equipment such as general purpose computers and software?
16316 DR. ROYCROFT: Yes.
16317 MR. HENRY: So using a composite depreciation rate for all this plant is an imperfect measure to reflect the difference in plant across carriers?
16318 DR. ROYCROFT: It would be less than perfect.
16319 MR. HENRY: Are you aware that Bell Canada, in its TFP studies, uses six categories of plant?
16320 DR. ROYCROFT: I was not aware of that particular point. I would say that is probably less than perfect as well.
16321 MR. HENRY: I understand the FCC study does not include land as an input. Is that correct?
16322 DR. ROYCROFT: That is correct.
16323 MR. HENRY: If different companies differ in their use of land, this could also affect the TFP results?
16324 DR. ROYCROFT: That could, although as an input my experience is the land does not play a major role in telecommunication service production.
16325 MR. HENRY: Are you aware that Bell Canada's TFP studies use land as an input?
16326 DR. ROYCROFT: I can accept that. I was not aware of that.
16327 MR. HENRY: Okay. Now, I understand the FCC staff TFP model was used by the FCC to establish this X factor of 6.5 per cent that we talked about -- ah, the sound is better.
16328 Under the U.S. system the FCC's price cap plan, as I understand it, applies to interstate access charges only. Is that correct?
16329 DR. ROYCROFT: That is correct.
16330 MR. HENRY: The majority of RBOC services, the basic local service, are regulated by state plans. Is that correct?
16331 DR. ROYCROFT: That is correct.
16332 MR. HENRY: The states that have X factors typically have X factors considerably less than 6.5 per cent. Would that be correct?
16333 DR. ROYCROFT: Yes.
16334 MR. HENRY: And no state has an X factor as high as 6.5 per cent?
16335 DR. ROYCROFT: Not to my knowledge.
16336 MR. HENRY: You note in your evidence that the FCC's price cap plan was challenged in the U.S. Court of Appeals. I think you mentioned it earlier this morning. I understand the court overturned the FCC's decision on the X factor and sent it back to the FCC for further consideration?
16337 DR. ROYCROFT: Which court decision are you speaking to this time?
16338 MR. HENRY: The first court decision, I think it was the Court of Appeal, District of Columbia.
16339 DR. ROYCROFT: Yes. The X factor component was remanded for further explanation. The court did not vacate the X factor, so it was applied to the companies.
16340 MR. HENRY: I understand the FCC further considered this matter and they reintroduced the 6.5 X factor, but this time they said the 6.5 X factor was not to be regarded as a measure of productivity, but rather served a different function. Is that correct?
16341 DR. ROYCROFT: That is correct. The context here is the calls -- what has come to be known as the calls order. The calls order represents a compromise with regard to the access charge issue between both local exchange carriers, the RBOCs and long distance carriers. In that order the X factor was no longer referred to as having a productivity component, but rather the X factor took on a role as a means to transition certain access prices toward cost.
16342 MR. HENRY: Right. I understand when the FCC did that, that was also appealed to the U.S. Court of Appeal. I think that was the decision that you mentioned at the beginning was just rendered in September 10th, I think you said --
16343 DR. ROYCROFT: That is correct.
16344 MR. HENRY: -- the U.S. Court of Appeal.
16345 I distributed that decision and I wonder if we could now turn to it. It is entitled, "Texas Office of the PU Council Versus FCC".
16346 MR. HENRY: "Texas Office of the Public Utilities Council Versus the FCC".
16347 Could you turn to page 10 of that document, please?
16348 Now, as you say, this was just rendered last month. The court goes through a little bit of the history that we have discussed, but I would like you to just bear with me for a moment. I just want to read some of the paragraphs here to put in context what exactly happened.
16349 I will start at paragraph 57. The court says:
"We also remand the X factor issue, finding that the FCC lacked a rational basis in the record to support the 6.5 per cent figure. Prior to the calls order, the FCC had designated the X factor as a proxy for the increase in the LECs productivity minus the rate of regulation. The price caps for local services were reduced each year by the percentage represented by the X factor. The X factor thus had the effect of passing down to consumers the savings from increased productivity.
In 1997, the FCC set the factor at 6.5 per cent, and on a petition for review, the D.C. court reversed and remanded the X factor issue, holding that there was no rational relationship between the 6.5 per cent figure and the alleged increase in productivity. In its calls order, the FCC reintroduced the same 6.5 X factor, but stated that the revamped X factor serves a different function, as a transitional mechanism that operates to reduce rate at a certain pace and is no longer linked to a specific measure of productivity.
Therefore, the FCC argues that the calls order does not conflict with the D.C. court's remand order in USTA because the court had only required further justification of the 6.5 figure in light of its role as a productivity proxy and now that the X factor no longer is tied to productivity, the FCC claims that the 6.5 per cent figure is acceptable. We disagree." (As read)
16350 That is a bit of the history we just talked about.
16351 The court's decision this time on the new X factor -- if I can call it that, though not a productivity factor -- is in the next paragraph.
"The new X factor suffers from the same infirmity as the prior one. The FCC has failed to show a rational basis as to how it derived the 6.5 per cent figure. Even if the X factor is no longer tethered to any productivity measure, the FCC still needs to provide a rational explanation of how it derived the precise percentage. Otherwise, the FCC would have free reign to set the X factor arbitrarily and capriciously. It must justify why a 6.5 per cent X factor is a more appropriate rate reduction measure than, say, a .065 per cent or 65 per cent X factor." (As read)
16352 So I take it it's fair to say that this 6.5 per cent figure has not only been rejected twice by the Court of Appeals, but it has also been rejected by the FCC itself as a measure of productivity?
16353 DR. ROYCROFT: The FCC decided not to call it a productivity factor when it utilized the 6.5 per cent within the calls order.
16354 MR. HENRY: Could we turn back to the Illinois document for a moment, please?
16355 MR. HENRY: I want to go to page 93 this time.
16356 Are you there?
16357 DR. ROYCROFT: Yes, I am.
16358 MR. HENRY: Here again it is the hearing examiner's recommendations for an order to the Commission that would say the following -- I am looking at the last sentence of the first partial paragraph on the page. He says:
"We find it very telling that even the FCC has not adopted 6.5 per cent X factor as a productivity factor, but rather prefers to call it a transitional mechanism or a policy instrument. There remains serious methodological issues associated with the FCC's staff's prior analyses which forms the basis for a 6.5 per cent X factor." (As read)
16359 So now we have at least some people at the Illinois Commission also agreeing that there are flaws with the FCC methodology.
16360 DR. ROYCROFT: That is what this indicates.
16361 I don't think it is quite consistent with the history of the appellate process. The initial appeal of the FCC's X factor pointed to discrepancies in interpretation of the results with regard to the productivity model and what the FCC decided to focus on. So the D.C. Appellate decision indicated that the FCC itself, in utilizing the results of the total factor productivity study, had not sufficiently explained why their interpretation or use of data that had been produced by that TFP model was correct.
16362 The last sentence in the paragraph here in the Illinois Commerce Commission ALJ ruling, I'm not quite sure what the basis for that is. It certainly isn't the Appellate Court ruling because the Appellate Court ruling did not address methodology but rather the interpretation of results.
16363 MR. HENRY: Okay. I said that was the first area I wanted to go through was the TFP.
16364 I would like to now turn back to your regression analysis and what you concluded, explain some of the differences in those TFP results.
16365 So could you turn back to the Table 9 again? That was in Attachment TRR-2 to your evidence.
16366 MR. HENRY: Are we there?
16367 Now, I want to make sure I understand this table because I am no statistician.
16368 I think we established earlier that the second column called "Variable Name" lists all the explanatory variables that you conclude from your model explain the TFP results.
16369 DR. ROYCROFT: These are variables that I included in the analysis. In choosing these variables the availability of data is always a concern. So given the availability of data these were the variables that I included.
16370 MR. HENRY: Yes, fair enough.
16371 Would you agree that the results of any statistical regression depend on the variables used in the analysis? For example, if you used or included different explanatory variables in a model you could get different results?
16372 DR. ROYCROFT: In making the decision on the variables to include theory is always the starting point. You wouldn't want to willy-nilly include variables that had no relation or were otherwise unrelated to the analysis in question, but certainly the variables that you do include will influence the results.
16373 MR. HENRY: Fair enough.
16374 Similarly, if there are measurement errors in any of the variables used you could also get different results?
16375 DR. ROYCROFT: If there are errors in the variables that is a problem. It's a problem that people who perform statistical analyses are always cognizant of. So one of the things as a researcher that you have to do is to examine the sources and determine whether or not you feel comfortable with the sources. As a researcher I never include variables that I feel uncomfortable with as far as the validity --potential for validity of the information.
16376 MR. HENRY: This is why this sort of analysis is an art rather than a science, isn't it?
16377 DR. ROYCROFT: Well, it's also reflected in the statistical approach from the standpoint that in addition to estimated coefficients of the variables. confidence intervals, what are known as statistical confidence intervals for the variables, variable coefficients are also produced, which gives you a stronger way of interpreting the results.
16378 MR. HENRY: I didn't mean that as a criticism.
16379 DR. ROYCROFT: Not taken.
16380 MR. HENRY: Now, on Table 9 I want to see if I understand what this would tell me. So I just want to take an example and see if I have it right.
16381 The first six variables are all the variables of the various regulatory plans. So for example, the first one, SRR*FPC1 means state rate of return combined with federal price cap, first price cap plan?
16382 DR. ROYCROFT: That is correct.
16383 MR. HENRY: And number 6 would mean state price cap combined with federal price cap, plan two?
16384 DR. ROYCROFT: That is correct.
16385 MR. HENRY: Okay. If I go across to a coefficient -- let's take row 1. The coefficient says ".0132". So that would mean that the effect of moving from rate of return to a combination of state rate of return and the first federal price cap plan is to increase productivity by 1.32 percentage points. Right?
16386 DR. ROYCROFT: Correct.
16387 MR. HENRY: All of these six regulatory plans are incremental to the combination of state rate of return and federal rate of return. Correct?
16388 DR. ROYCROFT: That is correct.
16389 MR. HENRY: That's why we don't see on there "SRR/FRR" because that's what all these things are measured in relation to?
16390 DR. ROYCROFT: That is correct.
16391 MR. HENRY: Then row 7 to 13 lists a variety of other variables, not regulatory schemes, that could provide certain information. For example, if we go to row 8, TA-96 that is Telecommunications Act 1996 which introduced local exchange competition?
16392 DR. ROYCROFT: That is correct.
16393 MR. HENRY: So that would measure the effect of the introduction of local exchange competition on productivity?
16394 DR. ROYCROFT: In part. I also controlled for line growth to the extent that the Telecommunications Act of 1996 had an impact on line growth. That would be separately reflected in the coefficient on the line growth variable. So this would be other impacts of the Telecommunications Act of 1996 beyond line growth.
16395 MR. HENRY: Okay. Just going across the columns, again just to make sure I understand. I think we have done the estimated coefficient.
16396 Let's stick with line 8 again, the Telecommunications Act. I just want to understand that one more.
16397 Again, as we said, that minus .0389 means that, subject to the qualification as you just stated, the introduction of local competition decreased productivity be 3.89 percentage points.
16398 DR. ROYCROFT: Relative to non-Telecommunications Act of 1996 periods?
16399 MR. HENRY: Right. Right.
16400 Is that cumulative? Does that mean that every year you could expect a further 3.9 per cent in each of the years subsequent to 1996?
16401 DR. ROYCROFT: I don't think that you would rationally assume that number would occur year over year. It's an estimation based on the data and therefore at a particular point in time that is what the data is reflecting.
16402 MR. HENRY: So it is a one year effect?
16403 DR. ROYCROFT: It is not a one year effect. It is a reflection of what change the data indicates has occurred in the years under the Telecommunications Act of 1996 versus non-Telecommunications Act of 1996 years.
16404 MR. HENRY: Your study data went up to 1998. Does it at least mean that in 1997 there would be a 3.9 per cent increase in productivity and then in 1998 a further 3.9 per cent increase in total factor productivity?
16405 DR. ROYCROFT: No. Over the two -- over the period in question -- and in this case it was the years 1997 and 1998 -- the data reflected that with that period there was on average a 3.89 per cent negative impact on TFP.
16406 MR. HENRY: Right. But projecting out into the future would you say that those effects fade or continue to accumulate at that rate?
16407 DR. ROYCROFT: That would depend on the nature of the changes that were occurring in that particular period.
16408 For example, if the Telecommunications Act in those years 1997 and 1998 was causing the RBOCs to incur investments, in other words increase inputs that would lead to not a corresponding increase in output, then if those are one-time changes those could be captured here. If in subsequent years those sorts of transition input changes did not occur, then in other years of data you would expect to not find that same impact. So it would really depend on the nature of the changes that were occurring.
16409 MR. HENRY: But one of your conclusions is that one can expect from moving to price cap regulation -- I thought one of your conclusions was an annual increase in improvement and productivity growth. If, as what you just said, the Telecom Act one may be one time, may be two years, it may fade over time, could the same conclusion not apply to your regulatory regime variables?
16410 DR. ROYCROFT: No, it wouldn't because the time period associated with the regulatory regime variables is a much longer period of time. It would account for one time changes and it would account for ongoing changes to the extent -- you know, some of the price cap regimes, for example the federal communications price cap regime, was in place for a nine-year period during this study. Some of the state plans were in effect for five or six year periods.
16411 MR. HENRY: Wasn't the federal plan only in effect for one year?
16412 DR. ROYCROFT: Pardon me?
16413 MR. HENRY: Wasn't the federal plan only in effect for one year?
16414 DR. ROYCROFT: The FCC's initial price cap plan was instituted January 1, 1991.
16415 MR. HENRY: But for your variable FPC2, federal price cap plan 2 which you measure, which has the highest of these changes, way higher than any other, as I understand it was only in effect for one year?
16416 DR. ROYCROFT: That is correct.
16417 MR. HENRY: So the long-term conclusion that you stated doesn't apply there?
16418 DR. ROYCROFT: For those specific variables I would take a hard look. You know, in looking at the impact, especially if I look at rows 5 and 6 and compare those with rows 3 and 4, with the exception of row 4 I see numbers that are quite similar. With the exception of row 4 the numbers are quite similar. They are essentially in the ballpark in, the neighbourhood of 5 to 5.5 per cent. The federal price cap 2 tied with state incentive plans does yield a higher number.
16419 In interpreting the overall impact I would probably tend to focus more on the measure of central tendency or the average that I see across the other plans. Those other plans do reflect long periods of experience under price cap regulation at both the state and federal level.
16420 MR. HENRY: Look at row 10 for a moment. There is a variable there that puzzled me.
16421 Bell Atlantic and a coefficient of minus .0406, which I take it is four percentage points decrease in productivity relative to Pac Bell. Is that how I understand you did your study?
16422 DR. ROYCROFT: That is correct. Both the coefficients reported in rows 9 and 10 are essentially comparing the relative productivity growth of those holding companies versus Pacific Bell.
16423 MR. HENRY: What possible explanation is there for that?
16424 DR. ROYCROFT: I think this would likely be capturing some of the variation that was not perhaps directly measured in the total factor productivity.
16425 Furthermore, the Pacific Bell region had experienced much higher growth in general with regard to population growth, so it could be capturing some of the advantages that the Pacific Bell region has that were developed simply because they were able to exploit economies of scale and scope that were unavailable to Ameritech and Bell Atlantic region due to the slower growth rates that you see in those areas.
16426 MR. HENRY: But did I hear you say as your first example that it could be measurement errors in the TFP results, or measurement differences in the TFP results? I thought that was the first of your three?
16427 DR. ROYCROFT: I misspoke if I did say that.
16428 MR. HENRY: Well, what did you mean by the first of the three things you listed?
16429 You said you thought there could be differences in the way they measure data compared to Bell Atlantic and Ameritech?
16430 DR. ROYCROFT: I'm not sure if I said that there were differences in the way that they measured data.
16431 MR. HENRY: So you don't think that could be one of the causes?
16432 DR. ROYCROFT: No.
16433 MR. HENRY: So I take it you don't know what the cause is.
16434 DR. ROYCROFT: No. What I indicated was that the differences in the market environment between Pacific Bell and Ameritech and Bell Atlantic were different, that the Pacific Bell region had experienced much higher population growth than Ameritech and the Bell Atlantic regions and that it was likely that that growth was a contributing factor to higher productivity overall on the part of Pacific Bell.
16435 MR. HENRY: Wouldn't population growth be captured in your line growth variable which you have in line 7.
16436 DR. ROYCROFT: It could be reflected in that, but there are other factors that are not directly controlled with that line growth. The line growth simply is measuring switched access lines.
16437 MR. HENRY: So whatever the reason -- you are speculating on these reasons. Correct?
16438 DR. ROYCROFT: With regard to the difference, I believe that the market environment in the Pacific Bell region was more favourable for total factor productivity growth than in the Ameritech and Bell Atlantic regions.
16439 MR. HENRY: We are to conclude that for speculative reasons Bell Atlantic and Bell Ameritech can be expected to have about 4 percentage points per year lower productivity than Pac Bell. That is the conclusion from that?
16440 DR. ROYCROFT: That is what the data reports, that the difference is approximately 4 per cent per year.
16441 MR. HENRY: Is it possible that if we included other variables that it would affect some of the coefficients of some of these other variables?
16442 DR. ROYCROFT: Certainly if you put more variables in it can have an impact on the coefficients.
16443 MR. HENRY: Let's come back to the regulatory variables in lines 1 to 6. Here I think we established earlier we have a various combination of state regulatory, state incentive and state price cap plans with federal cap plan 1, federal price cap plan 2, and federal rate of return.
16444 According to your analysis, if I look at line 4, the effect of moving from rate base rate of return to incentive regulation at the state level, and second generation price caps at the federal level, is to increase TFP growth by -- do I read that correctly, 8.35 percentage points per year?
16445 DR. ROYCROFT: As compared to rate of return regulation.
16446 MR. HENRY: Is that plausible?
16447 DR. ROYCROFT: Certainly.
16448 MR. HENRY: Is it cumulative? It accumulates each year?
16449 DR. ROYCROFT: Total factor productivity is not a cumulative measure. We are looking at growth.
16450 MR. HENRY: Well, okay. So you get 8.35 per cent growth one year and another 8.35 per cent growth the next year. Correct?
16451 DR. ROYCROFT: Could you repeat the numbers?
16452 MR. HENRY: You would get 8.35 per cent growth the first year and another 8.35 per cent growth from that base the next year.
16453 DR. ROYCROFT: That is an --
16454 MR. HENRY: That is an interpretation --
16455 DR. ROYCROFT: -- interpretation of it. As I indicated earlier when we discussed this particular variable, given that the federal price cap plan 2 -- which was the plan that adjusted the X factor upward and also removed the profit sharing constraint entirely -- is only tracked for one year, I would be cautious in interpreting that number. Rather the values that are reported in rows 3, 5 and 6 are, in my mind, more representative of performance that could be expected year over year with regard to the improvement in total factor productivity versus rate of return regulation.
16456 MR. HENRY: Well, let's look at line 4 compared to line 8.
16457 As I look at it, the only difference between those two scenarios is that line 4 is state incentive regulation scheme and line 8 is state price cap scheme.
16458 DR. ROYCROFT: I'm sorry, line 8 is Telecommunications Act of 1996. Could you --
16459 MR. HENRY: I'm sorry. Line 6. Are you with me?
16460 DR. ROYCROFT: Line 4 and line 6. I'm with you.
16461 MR. HENRY: The coefficient is higher on line 4 than it is on line 6 by .0268, if you take the difference.
16462 What that means is that we could expect state incentive regulation to actually produce 2.68 percentage points more productivity than state price cap regulation?
16463 DR. ROYCROFT: No, that is not the way you could interpret that.
16464 That variables are combined variables. It is the combination of state incentive and federal price cap with --
16465 MR. HENRY: But the federal price cap is the same in both cases?
16466 DR. ROYCROFT: That is correct, but the state regime is not.
16467 MR. HENRY: Well, that's right.
16468 DR. ROYCROFT: For example, in the state price cap there is a potentially different set of incentives than are present in the state incentive plan. It could be that what is being observed in line 4 is a superior response to the new price cap plan in the state incentive environment, whereas in line 6 the incentive structure provided by the state price cap may have already introduced one-time shifts of -- one-time adjustments in response to the improved incentives.
16469 MR. HENRY: I take it from the conversation we have had so far that you would at least agree that we must be cautious in projecting the future from these kinds of results?
16470 DR. ROYCROFT: I would always encourage reason. If there are to be errors, they should be on the side of being conservative. However, the information that is provided in my Table 9, I believe, shows a basis for conservative conclusions about the impact of moving from rate of return regulation to alternative regulation schemes, especially price cap regulation.
16471 I would not encourage decisions to be made based on row 4 alone, but rather to take row 4 into context with the other data points that are shown in Table 9, which I believe show that over a long period of time total factor productivity gains occur and are sustainable in alternative regulation environments, especially price cap environments.
16472 MR. HENRY: Okay. Now, you used growth in lines in your model. Correct?
16473 DR. ROYCROFT: That is correct.
16474 MR. HENRY: We wondered if local calls per line might also be a useful variable, because the number of local calls per line may vary by company. So we --
16475 DR. ROYCROFT: I'm sorry.
16476 MR. HENRY: Local calls per line.
16477 DR. ROYCROFT: Could vary by?
16478 MR. HENRY: By company.
16479 DR. ROYCROFT: So could line growth. I mean, line growth is a company.
16480 MR. HENRY: Yes, fair enough. So we didn't take out line growth. We added in another variable and redid your regression for local calls per line.
16481 I wonder if we can turn to the document I distributed to your counsel on Friday, called "Dr. Roycroft's model with growth in local calls per access line".
16482 Are you with me?
16483 DR. ROYCROFT: Yes.
16484 MR. HENRY: Here we have redone your regression using the same software you use. The only thing we did differently is to add a new variable called "Local call per access line growth", that is LCPAG on line 13. We have given you the source data in the attachment.
16485 I don't know if you have had a chance to do this, but could you accept this, subject to check?
16486 DR. ROYCROFT: I have not had the opportunity to reproduce these results, but I can accept them.
16487 MR. HENRY: Sure. Thank you.
16488 In our line 13 we see we have a T ratio in the last column of 24.3 per cent. I won't bore the room with that. I think you can agree that is much higher than the threshold of 1.96, so that this means that this variable is statistically significant?
16489 DR. ROYCROFT: That is correct.
16490 MR. HENRY: Now, is it possible that this is, for example, a missing variable that could at least partially explain the mystery of Bell Atlantic and Ameritech versus Pac Bell?
16491 For example, if we look at row 9 and 10 compared to your rows 9 and 10, the Bell Atlantic and Ameritech coefficients are lower, aren't they?
16492 DR. ROYCROFT: Yes, they are. The question, though, is whether or not they are statistically different. I don't believe that they are.
16493 What is now reported on this exhibit is the confidence intervals associated with these estimated coefficients. I have the conference intervals for the results that are reported in Table 9. What I observe is that the confidence intervals overlap with these values and, as a result, if you have -- I suspect that the confidence intervals associated with these coefficients would overlap, given how close the values of the coefficients are, which would indicate on a statistical basis you can't tell them apart.
16494 MR. HENRY: When you check, you could check, if you would, the confidence intervals and let us know if that is the problem or not.
16495 DR. ROYCROFT: I would be able to tell you whether or not they are statistically different if the --
16496 MR. HENRY: Right.
16497 DR. ROYCROFT: -- confidence intervals don't overlap.
16498 But, as I indicated, given the values that I do have on the confidence intervals reported for Table 9, I am almost certain that they do overlap. But I will verify that.
16499 One other point on the local calls variable as a variable that is going to be examined over this 13-year period, local calls, as a defined item change over time, both from the standpoint of EAS and also from the standpoint of toll competition. It has been quite common in the United States to see as local toll competition merged that the incumbent local exchange carriers who competed against IXEs, would redefine local calling areas to take over previous toll calls.
16500 So the local calls as a variable may have a problem from the standpoint that local calls don't necessarily mean the same thing at the beginning period and end period.
16501 MR. HENRY: If we look at this exhibit again, up on the 1 to 6 regulatory regime variables, they have also changed quite a bit, haven't they? For example, in line 6, which is the combination of state price cap and federal price cap 2, that goes from .0567 to .039. Line 2, state incentive with federal rate of return actually goes from a positive number to a negative number, which I take it would mean the move to state incentive regulation from state rate of return regulation actually decreases productivity.
16502 DR. ROYCROFT: Yes. With regard to line 5, whether this value is statistically different, I suspect that it is not.
16503 My confidence interval on the -- actually in this case I think I can confirm it.
16504 The confidence interval had a 95 per cent. What this tells us is that on a statistical basis we can be certain to the 95 per cent level that we are looking at the right answers. My lower end for that particular variable is .402 and we are looking at .4055, meaning that this estimated coefficient lies within my confidence interval, which would mean that statistically we can't tell them apart.
16505 MR. HENRY: And you will check our confidence intervals?
16506 DR. ROYCROFT: I will check your confidence intervals, but in this particular variable, the state price cap/federal price cap, your coefficient that is estimated on this exhibit is within my confidence interval.
16507 MR. HENRY: Now, we also looked at your regression and noticed in Table 9, the same table, you used a variable at line 12 called "fibre". You describe that in your evidence, I believe, as a quantitative variable added to control for technology development.
16508 DR. ROYCROFT: Yes, that is correct.
16509 MR. HENRY: So this is to remove the effect on these results, the effect on productivity of technological change. Correct?
16510 DR. ROYCROFT: This is to help control for technological change.
16511 MR. HENRY: Right. Now, your variable, as I understand it, measures total fibre kilometres deployed by each company in the study. Correct?
16512 DR. ROYCROFT: Right, on a year-by-year basis.
16513 MR. HENRY: Now, total kilometres employed would ignore the effects of technology like switching, wouldn't it?
16514 DR. ROYCROFT: Yes. I wanted to include switching. There was not a complete data trend available for switching, therefore I chose, rather than to approach it with a missing data point approach, I selected to leave the switching out and to go with fibre only.
16515 MR. HENRY: And it would ignore other technology changes like data bases and intelligence in the network, like opto-electronic equipment, like fibre capacity changes as opposed to the length of fibre?
16516 DR. ROYCROFT: I think on the specific issues with regard to fibre electronics and fibre capacity that there would be a high degree of correlation across fibre and those sorts of technology deployments.
16517 I believe that fibre presents a good proxy from the standpoint that a company that was interested in being aggressive with technology rollout would likely, in addition to deploying fibre would be upgrading its switching as well.
16518 So I took fibre to be a reasonable proxy and believe that it shows a reasonable picture of company's attitude towards technology deployment.
16519 MR. HENRY: Don't you first lay fibre and then the capacity increases with new opto-electronic equipment and so on?
16520 DR. ROYCROFT: You are saying fibre kilometres is a measure for all of these things -- switching -- it is a good proxy for switching for opto-electronic equipment that increases capacity for data basis and intelligence in the measure.
16521 The single measure of fibre kilometres employed is a measure of that. Would you agree it is at least not a perfect measure?
16522 DR. ROYCROFT: Well, if I am from a telecommunications company and I am laying fibre, I am making an investment and, presumably, I want to be able to earn a return on that investment and incorporate it into my plant in a way that allows me to recover those investments, I am going to light the fibre at some point.
16523 So if I am going to deploy fibre, I would expect that the electronics would follow. Traffic would be migrated to the fibre as it is a lower-cost means of moving traffic across my network, and so the fibre would be lighted and utilized.
16524 Of course, it is not a perfect measure, but I believe it is a reasonable proxy for technology deployment.
16525 MR. HENRY: Well, we wondered if there might be another variable to use to control for the effects of technology, and so we tried again to redo your regression using what I understand is a common econometric approach of including a variable known as time trend.
16526 I assume you are familiar with this kind of variable?
16527 DR. ROYCROFT: Yes, I am.
16528 MR. HENRY: And, as I understand it, it uses the passage of time to represent technological change, for example, when there are a lot of technologies changing at the same time. And it is a respected thing to do in econometrics? Would you agree with that?
16529 DR. ROYCROFT: It is something that can be done under certain circumstances. More specifically, if you don't have other data available that makes a -- provides a quantitative measure of technology deployment.
16530 MR. HENRY: Fair enough. Could you turn to a paper, again, that I provided on Friday, called "Estimating the Effects of Diffusion on Technological Innovations in Telecommunications, the Production Structure of Bell Canada".
16531 It is a mouthful. That's a paper by the author Denny, Fuss, Everson and Waverman.
16532 DR. ROYCROFT: Yes.
16533 MR. HENRY: Now, you may not know this, but Doctors Fuss and Waverman, I think, are well known to this Commission. They have appeared in many past proceedings, although, perhaps, I am dating myself.
16534 The authors of this paper discuss the use of a time-trend variable to control for technological advance. And if you go to page 30, at the bottom, under "Indicators of Technical Change", the first sentence there says:
"The most common indicator of technical change used in econometric studies is the passage of time." (As read)
16535 So, again, I take it you agree that it certainly has been used and can be used.
16536 DR. ROYCROFT: Can be used. Sure.
16537 MR. HENRY: Then --
16538 DR. ROYCROFT: However, in this paper I don't believe -- there is no reporting of their using it. They indicate that they consider four variables, including time; but in reporting their results, it appears to me that they don't utilized the time trend -- or at least perhaps you can point to me where they report the statistical results associated with the time trend.
16539 What they do report the statistical results on are the --
16540 MR. HENRY: I agree with you --
16541 DR. ROYCROFT: The -- I'm sorry, the access to direct dialling and the number of phones connected to modern switching facilities. So--
16542 MR. HENRY: My only point was that they say the most common method is the time trend --
16543 DR. ROYCROFT: But they specifically reject this method and go on to use specific data that they have available and, in my mind, that indicates exactly my thinking on this issue, as well, that if you have data that is available, why include a time trend.
16544 The time trend that you have included and show on this Exhibit essentially forces each company to deploy technology at exactly the same rate.
16545 What that does is take variability out of your data and in so doing, produce results that I really don't know how to interpret from the standpoint of -- if the results that you produce are logically inconsistent and especially inconsistent with economic theory --
16546 MR. HENRY: Well, we will get there, Dr. Roycroft. But you did say you had a better measure. And that better measure -- this whole discussion rests on fibre kilometres being a good measure of technological change. Right?
16547 DR. ROYCROFT: It was the best measure that I had available. I would have loved to have had other measures of technological change.
16548 I was short on data for switching and I made the decision rather than to proceed with switching and omitted observations -- simply because the data did not exist that it would be better just to leave fibre as the sole technology control.
16549 MR. HENRY: Fine. Thank you.
16550 Now, could you turn to our Exhibit called Dr. Roycroft's TFP Model With A Time Trend.
16551 A one-pager. Are you there?
16552 DR. ROYCROFT: Yes, I am.
16553 MR. HENRY: You will see that in the middle box here we have reproduced your results exactly as they were in the Table 9, and so you will see line 12 -- there are two line 12s -- the fibre line in the middle box is the one you use and time trend n/a. So that is just your results with no time trend.
16554 In the far right-hand box that we did is substitute a common technique of time trend for fibre. So the fibre line says n/a, and you will see we have a time trend variable in there.
16555 And, again, could you accept that at least we plugged the numbers and ran your program correctly subject to check?
16556 DR. ROYCROFT: I believe that you put the time trend in and took the fibre variable out.
16557 MR. HENRY: All right. Now, would you agree with me that the R-squared statistic that we get is higher than your R-squared. In fact, it is very high at .9991, as you see at the bottom of the estimated coefficient column.
16558 So that means that it is very high in statistical terms, doesn't it?
16559 DR. ROYCROFT: That indicates somewhat better predictive power for the regression.
16560 MR. HENRY: Right. And the F statistic, similarly, is orders of magnitude higher than yours, and that indicates a similar thing?
16561 DR. ROYCROFT: That is correct.
16562 MR. HENRY: And if we look at each of our variables in our results on the far right, the T ratio is extremely high, as well, is it not, indicating that all of the variables are significant?
16563 DR. ROYCROFT: That is correct.
16564 MR. HENRY: And if you look now at the Ameritech and Bell Atlantic variables in rows nine and ten, they are about half of what they were in your model? Is that correct?
16565 DR. ROYCROFT: That is correct.
16566 MR. HENRY: And what intrigues me is that if we go to the regulatory regime variables in lines one to six, every single one of them is now negative; whereas, every single one of yours is positive --
16567 DR. ROYCROFT: That increase --
16568 MR. HENRY: -- meaning that the to move to price of cap regulation actually decreased rather than increased productivity.
16569 DR. ROYCROFT: That is what your estimation, which on a -- from a theoretical basis, I don't buy your methodology, but what you have essentially proved here is that rate-of-return regulation is superior to price-cap regulation. And, you know, the results leave me somewhat at a loss for words, but I will find some. What this analysis does, you know, what my statistical analysis does is try -- it allows you to control for various influences that are affecting an observed outcome. What we observe is that over time total factor productivity growth has increased and that sort of information is reported in my paper and is shown specifically on page 13 in Table 7, that under various regulatory there is an observed increase and those observed increases correspond with the passage of time, as well.
16570 By performing the statistical analysis, we look more carefully at the influences that may be leading to the observed change. It is similar to a situation where if we observed somebody rowing a boat on the Ottawa River we might record a speed or clock a speed of five knots going down the river.
16571 But, certainly, the effort that rower was expending would depend on whether he or she was going upstream or downstream. In other words, the current would be affecting the performance of that boat. Likewise, if there was a wind condition, that could affect the performance.
16572 What the statistical analysis does is allow us to focus on that individual effort and take away the impact of the current or the wind, to use the rowing example or, in this case, to focus on the impact of regulatory and technology and other variables.
16573 So what the results that are reported in your exhibit show us is that there have been tremendous downward pressures placed on total factor productivity growth, by regulation, by the Telecommunications Act of 1996 and in spite of those tremendous downward pressures we are still seeing the observed outcome, the total factor productivity grow over time.
16574 What your results suggest is that technology is such a dominating factor that all of that other stuff really doesn't matter, we are still getting positive total factor productivity growth.
16575 Now, if that's the case, then there is still a strong argument to be made for a total factor productivity offset simply because all we are doing is going to be passing on those technological benefits, those technological gains, to ratepayers.
16576 So there is still the justification, but the justification shifts if this true, and I don't necessarily believe that is true and I will go in for a moment here -- in another moment explain why I think there may be another problem; but there is still every argument to be made for a productivity offset if these results can be believed.
16577 Now, part of the reason -- and I have not -- given the timeliness of getting this information -- have been able to research this, is that the statistical method that is applied here is a pooled cross-sectional analysis that involves time and cross-sections.
16578 I'm not quite sure how a time trend variable performs. I have not done the research. I did not investigate it when I was doing my paper simply because given that I had the data that I thought was appropriate poxy for technology, I included that data and did not consider the time trend approach.
16579 But it may be that the use of a time trend in this specific statistical approach is generating some problems that, you know, are causing these wild shifts and, as your other exhibits indicate, you can alter the regression equation in other ways and get results that are quite robust, indicating similar to the ones that I produced and report in my paper.
16580 But this time trend is somewhat of a puzzle to me but nonetheless, even if you buy these results, I still believe they support a productivity offset.
16581 MR. HENRY: And even if you don't buy the results, doesn't the result of the analysis at least show that your model is highly sensitive to the variable you use.
16582 DR. ROYCROFT: But once again, if you believe that it is reasonable to ignore specific data that is available for the companies which shows the true variation in their deployment of fibre technology, your approach is to force the same trend, the same technology deployment, on each company and that, in my opinion, is a mistake.
16583 You are taking variability out of the data and whenever you take variability out of the data, you are essentially guaranteeing an inferior result.
16584 MR. HENRY: And just so I am clear, that variability relates only to the length of the fibre deployed.
16585 DR. ROYCROFT: Total fibre kilometres deployed.
16586 MR. HENRY: Right.
16587 Thanks very much gentlemen.
16588 Mr. Chairman, those are all my questions.
16589 THE CHAIRPERSON: Thank you Mr. Henry.
16590 Mr. Secretary, we will get numbers for Mr. Henry's exhibits and then we will take our morning break.
16591 MR. SPENCER: Thank you, we have Mr. Todd's CV, which will be introduced as ARC et al Exhibit 12.
EXHIBIT NO. ARC et Al 12: CV of Mr. John Todd
16592 MR. SPENCER: Mr. Matwichuk's CV will be ARC et al Exhibit 13.
EXHIBIT NO. ARC et al 13: CV of Mr. Greg Matwichuk
16593 MR. SPENCER: Dr. Roycoft's CV, ARC et al Exhibit 14.
EXHIBIT NO. ARC et al 14: CV of Dr.Trevor Roycroft
16594 MR. SPENCER: We have the May 22, 2001, Illinois Bell Telephone Company Order 98-0252, will be introduced as The Companies Exhibit 46.
EXHIBIT NO. THE COMPANIES 46: May 11, 20001, Illinois Bell Telephone Company Order 98-0252
16595 MR. SPENCER: Texas Office of Public Utility versus FCC, will be The Companies Exhibit 47.
EXHIBIT NO. THE COMPANIES 47: Texas Office of Public Utility versus FCC
16596 MR. SPENCER: Dr. Roycroft's TFP Model with Growth in Local Calls Per Access Line, The Companies Exhibit 48.
EXHIBIT NO. THE COMPANIES 48: Dr. Roycroft's TFP Model with Growth in Local Calls Per Access Line
16597 MR. SPENCER: Estimating the Effects of Diffusion of Technological Innovations in Telecommunications, will be The Companies Exhibit 49.
EXHIBIT NO. THE COMPANIES 49: Estimating the Effects of Diffusion of Technological Innovations in Telecommunications
16598 MR. SPENCER: Dr. Roycroft's TFP Model With a Time Trend, The Companies Exhibit 50.
EXHIBIT NO. THE COMPANIES 50: Dr. Roycroft's TFP Model With a Time Trend
16599 MR. SPENCER: Thank you, Mr. Chairman.
16600 THE CHAIRPERSON: Thank you, Mr. Secretary.
16601 So we will take our morning break now and reconvene in fifteen minutes.
--- Upon recessing at 1010 / Suspension à 1010
--- Upon resuming at 1030 / Reprise à 1030
16602 THE CHAIRPERSON: Ladies and gentlemen, we will come to order in a minute or so -- not a minute or so, a few seconds.
16603 Just while people are taking their seats, I just want to advise people that we have been able to rearrange our affairs so we won't be adjourning at 3:30 today, we can go right though until about five o'clock. Hopefully, that will allow us to make up a bit of ground.
16604 I suggest we, unless someone has a problem, still take a one-hour lunch break today. Given the fact we started a little early, we will probably take the lunch break, say, from 12:00 to 1:00. So we will go through from now until 12:00 and then break for lunch.
16605 We will now turn to the next party to cross-examination, which will be TELUS.
16606 Mr. Lowe.
16607 MR. LOWE: Thank you, sir.
EXAMINATION / INTERROGATOIRE
16608 MR. LOWE: Mr. Matwichuk, welcome.
16609 MR. MATWICHUK: Good morning, Mr. Lowe.
16610 MR. LOWE: I was looking at your CV, which is Exhibit No. 13, and something caught my eye. It was that you were a consultant to staff of the Yukon Utilities Board in the early '90s?
16611 MR. MATWICHUK: That's correct.
16612 MR. LOWE: That was in respect of a hearing and then a Court of Appeal appearance?
16613 MR. MATWICHUK: That is correct.
16614 MR. LOWE: That would be to the Yukon Court of Appeal?
16615 MR. MATWICHUK: I believe it was the Yukon Court of Appeal and it was B.C. Court of Appeal that heard the case.
16616 MR. LOWE: The B.C. Court of Appeal sits also as the Yukon Court of Appeal?
16617 MR. MATWICHUK: That's my understanding, yes.
16618 MR. LOWE: Did you advise the Yukon Board on the rate case that went to the Court of Appeal?
16619 MR. MATWICHUK: Yes, I did.
16620 MR. LOWE: Okay. Then after the decision the company appealed and then it went up to the Court of Appeal. Is that what happened?
16621 MR. MATWICHUK: That's my understanding, yes.
16622 MR. LOWE: Was there a decision issued by the Yukon Court of Appeal?
16623 MR. MATWICHUK: There was a decision, yes.
16624 MR. LOWE: Subject to check, is that the decision of Mr. Justice Goldie(ph), filed on April 9th, 1996?
16625 MR. MATWICHUK: Subject to check, that sounds correct.
16626 MR. LOWE: It is indexed Yukon Energy Corp versus Yukon Utilities Board, subject to check?
16627 MR. MATWICHUK: Sorry, could you repeat that?
16628 MR. LOWE: Yukon Energy Corp v. Yukon Utilities Board?
16629 MR. MATWICHUK: Yukon Utilities Corp, did you say?
16630 MR. LOWE: Yukon Energy Corp --
16631 MR. MATWICHUK: Yes.
16632 MR. LOWE: -- versus Yukon (Utilities Board)?
16633 MR. MATWICHUK: Oh, you said Board. Okay. That's correct.
16634 MR. LOWE: Okay, thanks.
16635 MR. MATWICHUK: I didn't hear you correctly the first time.
16636 MR. LOWE: Then, in addition to doing work on the electric side in the Yukon I see from your CV that you have done a lot of work on the electric side in Alberta. You have been consultant to the city, to N-MAX, you dealt with the purchase of power plants and been involved in a lot of regulatory proceedings, including transmission administrator hearings, distribution tariff hearings and the whole kind of suite of hearings that we have had on electric deregulation in Alberta. Is that right?
16637 MR. MATWICHUK: With respect to electricity, yes, that's correct.
16638 MR. LOWE: Thank you.
16639 Now, could you please turn to your evidence, paragraph 112? This is where you talk about earnings sharing.
16640 This is a little open-ended, but I was wondering if you gentlemen have a position on earnings sharing.
16641 MR. TODD: I will start because I filed evidence in the original price cap proceeding which addressed issues including earnings sharing.
16642 At that time my proposal was to adopt something along the lines of what had been used in the U.S. in terms of the options of having different levels of productivity and different ratios of sharing.
16643 The Commission did not accept that proposal. We established a first round price cap regime which did not have any explicit earnings sharing.
16644 In raising the topic earnings sharing it is important to differentiate between sharing of benefits. There is a sharing concept generally, which price caps and all regulation is all about, and explicit earnings sharing, which requires a determination of earnings to be shared and then an allocation of them.
16645 Given that we have not had an earnings sharing regime during the first term of the price cap, it does make it a little bit more difficult to implement earnings sharings at this time. Clearly, we would not be wanting to get into having hearings like the old hearings to determine the earnings to be shared. You would have to introduce a mechanism of, in effect, an audit of utility segment returns to identify the earnings to be shared, and rely on our auditor to do that in order to have administrative simplicity.
16646 Given that complexity, and given the incentive issues that the Commission identified in its first decision, the original price cap decision, my view is that it is preferable to fully capture the customer share of the benefits in the productivity factor rather than going with a reduced productivity factor, which is more conservative and reflects uncertainty and having explicit earnings sharing mechanism.
16647 They are alternatives and you use them in different places. It is essentially to deal with the uncertainty as to what future productivity is. But given where we are at today, I certainly lean in the direction of reflecting those benefits in productivity.
16648 MR. LOWE: Anything to add?
16649 MR. TODD: The only thing that I was going to suggest, Mr. Lowe, is that I believe it's our preference that we use an implicit earnings sharing. I think what we mean by that is making sure we get the productivity factor parameters correct.
16650 MR. LOWE: Okay. So you are not proposing any explicit earnings sharing?
16651 MR. TODD: No, but that is taken within the context of our proposals, our package. If you change one piece of it you change other pieces of it. For example, if you are talking significantly lower productivity, then we would say the way you would offset that conservatism on productivity would perhaps be by putting in an earnings sharing mechanism -- explicit.
16652 MR. LOWE: Okay. Then if you did do earnings sharing, have you given any thought to what the dead band would be and whether you would have any reverse tapering or anything like that? It's fine if you are just saying that.
16653 MR. TODD: No, we haven't looked at that is this particular context. It's not an issue that seems to be really on the table.
16654 MR. LOWE: Okay. Now, I would like to turn now to your evidence, paragraph 35.
16655 MR. TODD: Sorry, 35?
16656 MR. LOWE: Thirty-five. Where you quote, with approval, I take it, and excerpt from a book written by Dr. Roger Morin in 1994. Dr. Morin appears before regulatory tribunals providing expert evidence on rate of return evidence. Is that right?
16657 MR. MATWICHUK: That's correct.
16658 MR. LOWE: He would be a professional rate of return witness?
16659 MR. MATWICHUK: That's our understanding, yes.
16660 MR. LOWE: The quote says:
"The validity of the parameters in a price cap plan can only be assessed by reference to some rate of return benchmark." (As read)
16661 Do you see that?
16662 MR. MATWICHUK: Yes.
16663 MR. LOWE: Were you surprise to hear from someone who has a stake in participating in rate of return hearings to say something like this? Do you find that surprising?
16664 MR. MATWICHUK: Did we find it surprising?
16665 I'm not sure what you mean by "has a stake" in rate of return hearings.
16666 MR. LOWE: There is an industry, if you will, of consultants and, I have to admit, lawyers, who thrive on rate of return hearings. Isn't there some interest in perpetuating those sort of proceedings?
16667 MR. MATWICHUK: I would expect that if Dr. Morin is an expert independent witness that motivation wouldn't be driving the statement one way or another.
16668 MR. LOWE: Okay. Okay.
16669 Do you think the rate of return is relevant?
16670 MR. MATWICHUK: I think what we have presented in our evidence is that the achieved rate of return is relevant to these proceedings. There has to be some sort of benchmark that the Commission can rely on.
16671 It is one of the indicators, Mr. Lowe. I believe that you have seen elsewhere in our evidence that the degree to which investors earn a rate of return just equal to their cost of capital that they supply is one of the measures of a competitive market.
16672 I also note that Oftel, the regulator in the UK, when they produce a model for the X factor, they do it on the basis of the expectation that the rate of return will equal the cost of capital throughout -- or by the end of the price cap period.
16673 MR. LOWE: Thank you.
16674 MR. TODD: Mr. Lowe, rate of return benchmark does not necessarily mean evidence such as Dr. Morin would produce which sets a benchmark rate of return itself in an explicit rate of return hearing. It could refer to the kind of filings we have in this proceeding which provide the RACE for utilities segment results, that provides some information which is, in effect, a rate of return benchmark.
16675 MR. LOWE: Now, in 1997, when we first initialized price caps, we looked at 1997 results and then we overlaid some events which would occur in the price cap period, such as the full amortization of shareholder entitlement in the case of TCI, and that reduced the contribution rate.
16676 This may be taking you back a bit, bit it is referred to at paragraph 28 of Decision 97-9. Does that ring a bell at all?
16677 MR. TODD: Yes.
16678 MR. LOWE: Thank you.
16679 Say there were some changes which you knew would materially increase earnings in the first year of the price cap period, extra revenues. Would that be something you would want to take into account if you were undertaking the exercise of re-initializing price caps?
16680 MR. TODD: Firstly, what do you mean by "re-initializing price caps"?
16681 MR. LOWE: Back in 1997, for example, do you have any disagreement with looking at material changes in revenues which may occur in taking those into account?
16682 MR. TODD: The objective is to set a price cap regime, set a formula and going-in rates that are appropriate on a going-forward basis. So any factors that you can anticipate should be taken into account. You do not base it on historical reality if history is not -- if the future is not going to be the same as the past.
16683 MR. LOWE: Thank you.
16684 Could you, please, refer to the transcripts, Volume 2, page 391?
16685 MR. TODD: Yes, we are at page 391.
16686 MR. LOWE: Mr. Farmer refers to the effect of the contribution decision, Decision 2000-745, and then he looks at Aliant and he says:
"...you look at Aliant, one thing you discover is the amount of contribution revenues that they are going to receive and 2002 goes down drastically. For Aliant it's by $78 million, which is a lot of money for Aliant. That is the net impact of the fact that they are going to be paying in 2002 less contribution than they will in 2001, but also it takes into account the fact that they will be receiving less contribution revenues. Both numbers, of course, on the utility side of the business and that $78 million is worth about 5.4 per cent on the utility rate of return.
16687 Do you see that?
16688 MR. TODD: Yes.
16689 MR. LOWE: Then, I don't know if you need to turn to it, but in the transcripts, Volume 13, Mr. Grieve commented that there was a similar impact of $400 million on the TCI utilities segment.
16690 If you want to turn to that, it's transcript Volume 13, 2494 and 2495.
16691 What I was hoping to do is refer you to TELUS(CRTC)16Mar01-405, Attachment 9. I'm not sure you have that, so I will --
16692 What I wanted your help with is --
16693 THE CHAIRPERSON: Mr. Lowe, could you just give us that reference again?
16694 MR. LOWE: Oh, I'm sorry. It's TELUS(CRTC)16Mar01-405, Attachment 9.
16695 I'm not asking you to buy into the $400 million number, but accepting that or assuming that amount of a reduction in net revenues is it reasonable to think that the after tax impact of a reduction in contribution revenues of $400 million would be $177 million. That is just tax affecting it?
16696 Does that sound about right to you, Mr. Matwichuk?
16697 MR. MATWICHUK: We will take it, subject to check.
16698 MR. LOWE: Okay. Turning to page 3 of 3, if you take into account a reduction in contribution revenues after tax of $177 million and overlay this impact on the 2001 results, that would reduce the utility segment earnings from $405 million to $228 million. That's the math. Right?
16699 MR. TODD: That's the math, yes.
16700 MR. LOWE: Subject to check, this would result in a utilities segment ROE of about 9 per cent. I'm told it's 8.8 per cent, but 9 per cent is close enough for me.
16701 Does that sound about right?
16702 MR. TODD: Are you referring to -- there are two lines with equity return on common equity book and return common equity regulated. Which are you referring to?
16703 MR. LOWE: Book.
16704 MR. TODD: The one that appears as 14.6. You are talking about the impact on that?
16705 MR. LOWE: It's the $2501 million, average common equity.
16706 MR. TODD: Okay.
16707 MR. LOWE: Subject to check, 8.89 per cent?
16708 MR. TODD: Okay.
16709 MR. LOWE: Thanks.
16710 Now, do you have the state of competition report?
16711 MR. TODD: Yes, we do.
16712 MR. LOWE: You have a copy of the opening statement of ARC, which is ARC EXHIBIT NO. 1?
16713 MR. TODD: Yes, we got that just during the break, at your request.
16714 MR. LOWE: Thanks.
16715 Now, this evidence, this second generation price cap evidence, it is joint evidence prepared on behalf of ARC, BCOAPO, CAC Manitoba and the City of Calgary. Correct?
16716 MR. TODD: Our evidence is, yes.
16717 MR. LOWE: I take it that the parties to this proceeding are trying to help the Commission reach a decision that will "foster the development of healthy sustainable competition". I took that quote from the opening statement.
16718 MR. TODD: I think words along those lines appear in a number of places, including our evidence.
16719 MR. LOWE: Page 2.
16720 MR. TODD: I see the reference in opening statement of ARC et al.
16721 MR. LOWE: Okay. That's what the parties here that you are representing are trying to do?
16722 MR. TODD: I will have to let them speak for themselves, but that's what this hearing is about, among other things.
16723 MR. LOWE: Okay.
16724 Then turning to the state of competition report, Exhibit CRTC No. 5, it says on the first page in the Executive Summary at the bottom:
"A key to facilities-based competition is the resolution of access issues related to municipal rights-of-way, support structures and multi-unit buildings." (As read)
16725 Do you see that?
16726 MR. TODD: Where's this? Oh, in the Executive Summary, page (i). Little (i), right. Okay.
16727 Yes, I see that statement.
16728 MR. LOWE: Then on page 6, last paragraph:
"The Commission has determined the terms and conditions for access by Ledcor Industries and its affiliates to municipal rights of way in Vancouver. The matter is currently before the Court of Appeal."
16729 Do you see that?
16730 MR. TODD: Yes, the last paragraph there.
16731 MR. LOWE: That decision, subject to check, is Decision 2001-23?
16732 MR. TODD: Yes, to my recollection.
16733 MR. LOWE: Then turning to page 26:
"Resolution of access issues related to rights of way support structures and multi-unit buildings is a key to facilities-based competition." (As read)
16734 Do you see that?
16735 MR. TODD: The second paragraph?
16736 MR. LOWE: Yes.
16737 MR. TODD: I see that sentence.
16738 MR. LOWE: Now, gentlemen, do you consider it possible that the uncertainty surrounding access to municipal rights of way is a barrier to entry to the local market?
16739 MR. LOWE: Mr. Todd, do you have any views?
16740 MR. TODD: Having worked with the City of Toronto on that issue, from my awareness of the way things have developed access has been proceeding. The issue really revolves around the fees that would be paid more than anything else, is my understanding of it. The Commission has made the determination that it certainly could not be seen as a barrier to access.
16741 I suppose if some parties felt that the courts were likely to overturn that and lead to a radically different result, that could be a barrier. But from my understanding of activity, and the applications being received by the City of Toronto is one example, I would not consider it a barrier.
16742 MR. LOWE: So in your view there is no barrier relating to access to municipal rights of way right now?
16743 MR. TODD: I mean, it could be a modest barrier but it is not a barrier that is stopping entry. There is deployment in downtown cores of major cities. Certainly in Toronto work is proceeding, as I find every day as I am trying to walk to my office and dodging around construction sites that are often telecommunications facilities.
16744 MR. LOWE: A lot of activity going on anyway. Right?
16745 MR. TODD: Yes.
16746 MR. LOWE: Thank you.
16747 Mr. Matwichuk?
16748 MR. MATWICHUK: Well, Mr. Lowe, it is not a barrier that has the magnitude or the significance or the impact that access to capital would have for competitors.
16749 MR. LOWE: Is it a barrier or just not a significant barrier?
16750 MR. TODD: I think probably both. Certainly my view is that there are a number of barriers. Relative to other barriers, this one would be unimportant.
16751 MR. LOWE: Okay.
16752 MR. TODD: When I'm talking barriers I am talking barriers to the provision of local services generally, which means on an ubiquitous basis to all segments of the market in all parts of the country.
16753 This barrier is a minor one and really is only a factor. It is a small factor in the most attractive segments of the market which is why it is so hotly disputed. It is the downtown cores to business customers that are being dealt with there.
16754 MR. LOWE: I'm told that the City of Calgary has adopted a business practice that it will only accept bids for the supply of telecommunications services from carriers that have signed Calgary's Municipal Access Agreement. So if you are a carrier with facilities in Calgary you can only do business with the City if you sign an MAA. Subject to check, that is a City of Calgary document GP2001-14, dated March 1, 2001.
16755 Does that sound about right to you, gentlemen?
16756 MR. TODD: I had heard about that. I don't know what the current status of it is.
16757 You would be more familiar -- Mr. Matwichuk maybe, but I see that is still in force.
16758 MR. MATWICHUK: That is the extent of my knowledge on that as well, Mr. Lowe.
16759 MR. LOWE: So the City of Calgary is willing to say, "TELUS, we don't need you for our telecommunications needs. We can get whatever we need on the market. So if you don't want to sign our MAA we will get our stuff from other folks." Right? That is the essence of it?
16760 MR. TODD: I would say the City of Calgary is in a position to deal with competitors, yes.
16761 MR. LOWE: So we can take it that the monopoly is over at least as far as TELUS is concerned in the City of Calgary? That is the message we can take from this business practice?
16762 MR. MATWICHUK: Are you talking about the subscribers within the city or are you talking about the City of Calgary corporate entity?
16763 MR. LOWE: The City of Calgary corporate entity.
16764 MR. TODD: I would say that is true and my comments at paragraph -- or our comments at paragraph 153 leading to a recommendation on the basic business constraint are totally consistent with that, which is that in major centres for the business market there is a fairly pretty much effective competition and there is not a significant concern. Therefore, we are not suggesting tight constraints there.
16765 So yes, that observation of yours is totally consistent with what we are seeing in our evidence.
16766 MR. LOWE: It is that power of choice that is out there.
16767 MR. TODD: For the City of Calgary and others, other large businesses certainly, especially in the major cities.
16768 The City obviously is a very major business within that city. It is equivalent to a large corporation operating in the city.
16769 MR. LOWE: Thank you.
16770 Now, I circulated to you a document which is posted on a City of Calgary website and it is this N-Max document. Before I go there I wanted to -- MR. TODD: Is that a City of Calgary website or an N-Max website?
16771 MR. LOWE: I think it is linked from both the City of Calgary and the N-Max website and it is a separate site. It is to do with the sale of N-Max. There are a bunch of documents on that and this is one of them.
16772 Paragraph 119 of your evidence, it is page 24, footnote 37, you make a reference to the California electricity market and you make the observation that the disconnect between prices and costs was not sustainable.
16773 I was just wondering which of you gentlemen were providing the California example?
16774 MR. TODD: We both work in the electricity sector, therefore I am not even sure who came up with that cite, but we both would be capable of coming up with it as we both follow those issues.
16775 MR. LOWE: Okay. That's fair enough.
16776 This N-Max document, I take it that N-Max is a wholly-owned subsidiary of the City of Calgary. Is that right?
16777 MR. MATWICHUK: That's correct.
16778 MR. LOWE: This document, if you could look at page 1, it says:
"The City of Calgary is pursuing opportunities to sell its integrated utility N-Max Corporation." (As read)
16779 Then it says:
"The information summary was prepared to assist readers in understanding the business operations and financial status of the company." (As read)
16780 Do you see that?
16781 MR. MATWICHUK: Yes, I do, Mr. Lowe.
16782 MR. LOWE: So this document is targeted, to some extent, at potential buyers of N-Max?
16783 MR. MATWICHUK: Yes, that would be correct. Probably as well targeted to the many people of Calgary who are going to be making a serious decision today that you and I will not be able to --
16784 MR. LOWE: Thank you.
16785 MR. MATWICHUK: -- and that is the election.
16786 MR. LOWE: Now, I take it that since the City is the shareholder, and it is the one that would be selling N-Max, it would have had input into this document?
16787 MR. MATWICHUK: I'm not familiar with how this document was prepared, Mr. Lowe.
16788 MR. LOWE: Fair enough.
16789 Then if we turn to page 3 of the document there is a consolidated statement of earnings. You show the years 1999-2000 and then the first six months of 2001. Do you see that?
16790 MR. MATWICHUK: We do.
16791 MR. LOWE: Then footnote No. 1, which relates to the years 2000 and 1999, says:
"Deregulation of generation and retailing in the Alberta electricity market including the operation of the PPAs occurred on January 1, 2001. As a result, operating results in 1999 and 2000 are not indicative of future results." (As read)
16792 I take it this is telling the reader that, "Look, in 1999 and 2000 these results were before deregulation, they were rate of return type earnings, what you would expect from a plain vanilla transmission distribution utility and in 2001 and going forward things are going to be different."
16793 That is the message, isn't it?
16794 MR. MATWICHUK: The message is that there are different operations.
16795 Just to put a minor clarification, the deregulation that they are talking about here is strictly in the generation side of the business.
16796 MR. LOWE: That's fair enough.
16797 Then if we look at the net earnings for the first six months of 2001 there -- and I want to do a little math here -- it is a $183.3 million. If you doubled that, just made the assumption that continued, and I know it probably won't, you don't know what the prices are going to be and so on, but if you made that assumption you would have net earnings for 2001 of $366 million and then we have equity on the next page of $824 million.
16798 So if you use this $366 million and divided it into the equity, you would get an ROE of -- well, it would be above 20 per cent, wouldn't it?
16799 MR. MATWICHUK: Just on that, that is what the math would yield I would believe, yes.
16800 MR. LOWE: Thank you.
16801 Then if we could go to the last page of the document, could you read the top paragraph for me, please?
16802 MR. MATWICHUK: Are we coming back to your notional calculation there, Mr. Lowe, or are you finished with that?
16803 MR. LOWE: Oh, we will come back to that.
16804 MR. MATWICHUK: Okay. It's just that --
16805 MR. LOWE: This is just the earnings. I just wanted to talk about the earnings here and this note talks about an increase of 155 per cent.
16806 MR. MATWICHUK: Right. Because we are dealing with an entity here where the shareholders and the ratepayers are one and the same.
16807 MR. LOWE: I don't mind at all. We can talk about that later and I accept that. I just wanted to talk about this note.
16808 MR. MATWICHUK: So you are on?
16809 MR. LOWE: The very last page of the document. This is a note. This is the "Management Discussion and Analysis of the Second Quarter 2001 Results" and it says:
"Total revenues in the first six months of 2001 were $782 million, an increase of 155 per cent over the same period in 2000. The increase in revenues year over year was due to a 27 per cent increase in customer volumes, market-based pricing of the energy commodity in a deregulated industry, and export to the Pacific Northwest of electricity surplus to Alberta customers' requirements." (As read)
16810 I was wondering how much of this 155 per cent increase was due to the second factor, which is market-based pricing of the commodity in a deregulated industry.
16811 We thought that the increase in customer volumes would account for 15 per cent of it and I didn't really know what the Pacific Northwest volumes would have to do with it.
16812 Can you give me just some rough estimate?
16813 MR. MATWICHUK: Well, I expect it would be significant.
16814 I guess what I am wondering, Mr. Lowe is, obviously you know of the relevance of this more than I do in your questioning, but with respect to electricity we are talking about what has been a very volatile market across North America and prices have been influenced by gas prices as an input, by severe demand in supply conditions.
16815 It is a volatile market, particularly in Alberta where the pool is priced a day ahead on an hourly basis. So that is significantly different from a lot of other markets that were regulated and have been deregulated.
16816 MR. LOWE: Yes, and that is fair enough.
16817 Then on page 5 there is an overview of the regulatory environment and --
16818 MR. TODD: Did we get your last question answered, by the way?
16819 MR. LOWE: Did I get it answered?
16820 MR. TODD: I thought he said that --
16821 MR. LOWE: I thought the question --
16822 MR. TODD: -- most of it would have been --
16823 MR. LOWE: -- that most of it would have been.
16824 MR. TODD: -- most of it would have been at the higher market prices.
16825 MR. LOWE: That's good enough for me.
16826 MR. TODD: Okay. Yes.
16827 MR. LOWE: Page 5 there is a discussion of the regulatory environment. Mr. Matwichuk, it is maybe true that not all notions emanating from our province can be uncritically received, but this study here says that on electricity deregulation Alberta got it right. There is this reference to the centre for advancement of energy markets, this non-profit think tank and it ranks effective electricity deregulation. You can see Alberta was ranked number one in North America as the jurisdiction closest to full deregulation of electricity.
16828 Do you see that?
16829 MR. MATWICHUK: I see it, but don't believe it.
16830 MR. LOWE: You don't believe it?
16831 MR. MATWICHUK: Well, I think you would find that there is a fair bit of -- that is pretty controversial in terms of ranking. It is uncertain from this document as to what that ranking entails in entirety. There are certainly some significant parties in the Province of Alberta who would take strong exception to that ranking.
16832 MR. LOWE: What about you? Do you think that -- do you have any reason to think that this ranking is wrong?
16833 MR. TODD: We accept that this organization gave this ranking.
16834 If you read other sources, I would say that generally the literature -- when I refer to "literature" it is not really academic literature at this point because of the delays in publishing it is more a public utility fortnightly and other types of business/regulatory reviews -- would probably put Pennsylvania as number one in terms of success and Alberta would be above California but more like halfway between. I mean, California is widely seen as a total disaster, one of the reasons why they have backed out of customer choice recently.
16835 Alberta, certainly to Albertans -- and I do work in that jurisdiction with customer groups in the electricity sector and gas sector -- even the business organizations that were very, very strong supporters of deregulation prior to it happening have now backed off and have huge concerns about the impacts on them, because they were expecting to see rate reductions, as customers usually do when they are looking at deregulation, and they are seeing huge increases in the prices, so they are of a widespread view that it is a mistake.
16836 In Ontario, where we have not opened the electricity market yet -- it is still scheduled to be May, maybe -- there has been massive rethinking. It was supposed to be opened last May and it has been put off partly because of the Alberta experience, as well as California. So there is widespread concern.
16837 All I can say is, they are ranking Alberta at the top, then I suspect that 68 is not a passing score.
16838 MR. LOWE: So, Mr. Matwichuk, do you think this is erroneous information that is contained at page 5 of this document?
16839 MR. MATWICHUK: Well, it is one organization's ranking, but I think there are a number of concerns in the Alberta electric market --
16840 MR. LOWE: Well, just a second. Would this have been put in by the shareholder, the City of Calgary, and distributed to people around the world on the web if the City of Calgary thought this is just not right?
16841 MR. TODD: As you said at the beginning, this is a document which is targeted perhaps somewhat toward potential investors. I would think that given your concerns about the quote from Dr. Morin, you would be concerned about the incentives behind the quote that appears in this document.
16842 MR. LOWE: The incentive I guess is to tell investors that: Look, this is a jurisdiction which has gone ahead with deregulation and hasn't, as you said in the California case, turned back, backed out of customer choice?
16843 MR. TODD: Yes. I would say that if you are ranking jurisdictions from the perspective of the opportunities for the industry to make a big profit, it may rank high. However, many people rank them on a different basis which is: What is the impact on customers? If you rank it from what is the impact on customers you get a very different ranking than if you rank it on the basis of profits.
16844 I think you would see the same thing in telecom in a price cap regime. The rankings from the perspective of the companies with their returns of how successful price caps have been, would be very different from the ranking from the perspective of the impact on customers.
16845 MR. LOWE: From at least an investors standpoint, when they see California and it's backing out of customer choice and so on, that would be worrisome to them. I take it you would agree with that, right? Just looking at the target market here.
16846 MR. TODD: That would be worrisome to investors to have that kind of change, but the whole process obviously is very worrisome to investors, existing owners, customers, and very much so to politicians.
16847 MR. LOWE: Okay. then turning to page 9 -- I will get back to telephones eventually.
16848 MR. TODD: I thought I was in the wrong hearing room, actually. I am used to talking about this stuff in other places.
--- Laughter / Rires
16849 MR. LOWE: The heading at the bottom "Alberta Electric Industry Dynamics". It says that there was a tight supply in 2000. That is the second last paragraph.
16850 Then it says at the bottom of the page:
"Approximately 6500 megawatts of new supply projects have been announced for Alberta over the next five years." (As read)
16851 Do you see that?
16852 MR. MATWICHUK: We do.
16853 MR. LOWE: Then turning to the next page, page 10, it shows the power prices in Alberta. We can see in 1999 the pool price is sort of -- the average: 3.3 cents level -- or rather, 1998. This is not in the graph, it is in the description above.
16854 It is 3.3 cents in 1998, $33 per megawatt hour. That is pretty low by North American standards.
16855 In 1999, it creeps up to 4.3 per cent.
16856 Then in 2000 it starts to climb in the May to September timeframe and averages out at 13 cents a kilowatt hour.
16857 Then it drops back to 9.5 cents in the year 2001.
16858 Do you see that?
16859 MR. MATWICHUK: We see it.
16860 MR. LOWE: So I take it what happened is, prices were low before deregulation and then prices increased as industry was being deregulated. That has to do with some of the other forces you were talking about, Mr. Matwichuk, like the fuel prices and, you know, the whole Pacific Northwest issues and so on.
16861 MR. MATWICHUK: Well, I think there are some other issues. If you are talking about the price spikes that took place in 2000, there is the potential -- or was the potential, it may still exist -- the potential for some market power influence on prices.
16862 MR. LOWE: Right. Then in 2000 -- not that I agree with that, but anyway.
16863 In 2000 in August -- but it was a good shot --
16864 MR. TODD: You did say, "Right." We got it on the quote --
16865 MR. LOWE: No. Strike that.
--- Laughter / Rires
16866 MR. LOWE: In 2000, August, that is when the auction occurred, the PPA auction. Right?
16867 MR. MATWICHUK: The first auction.
16868 MR. LOWE: Right. So the Alberta government could have looked to the rising prices and said: No, well, let's just put a lid on it and not do it. But they didn't do it. They went ahead, didn't they?
16869 MR. MATWICHUK: Well, they did put a lid on it, as you recall.
16870 MR. LOWE: Well, they did hold the auction?
16871 MR. MATWICHUK: They did hold an auction.
16872 MR. LOWE: Then they held a subsequent map auction after that?
16873 MR. MATWICHUK: Yes, but they also capped prices.
16874 MR. LOWE: That is right. They were capped at, I think, 8 cents a kilowatt hour and then that was subsequently changed to 11 cents a kilowatt hour?
16875 MR. MATWICHUK: That is correct.
16876 MR. LOWE: Thank you.
16877 Then if we look forward after July of 2001, where is the price going? Do you know where this market-based commodity price is going to go?
16878 MR. TODD: Are you talking about in the historical months since then, i.e., in August/September?
16879 MR. LOWE: Oh, no, no. Well, I mean, we can get on the Power Pool web site and find those out, but I am talking about say 2002 and beyond.
16880 MR. TODD: Firstly, electricity pricing is essentially a continental market now.
16881 MR. LOWE: Yes. Subject to interties and --
16882 MR. TODD: Yes. There are constraints, but there is a cascading of prices across the continent.
16883 The most commonly used word, I think, with respect to prices is "volatile.
16884 MR. LOWE: Yes.
16885 MR. TODD: So they will be up and down all over the map.
16886 There is general recognition, certainly in the hearings I have been in, that the kinds of price spikes that we have seen in the past are quite possible to occur again.
16887 MR. LOWE: Yes.
16888 MR. TODD: What we have seen in the past was a juxtaposition of unfavourable circumstances in terms of available supply and demand being peaked, partly economic growth, all sorts of factors.
16889 The illustrations usually given is that we are all used to, as consumers, seeing the price of gasoline at the pump when you go to fill up bouncing around quite a bit. We are likely to see both electricity and the gas markets in a deregulated mode of the commodity being as volatile or more volatile than that.
16890 Actually, the fundamentals as Mr. Matwichuk referred to earlier on in the electricity market makes it probably the most volatile commodity of all because this hour head pricing and so on.
16891 MR. LOWE: No storage.
16892 MR. TODD: Sorry?
16893 MR. LOWE: No storage.
16894 MR. TODD: No storage unless you go to B.C. where there is hydroelectric power.
16895 Therefore, it is quite likely that we will see a great deal of volatility in the future.
16896 MR. LOWE: When you look at the forward price you can take some comfort from the approximately 6500 megawatts of new supply projects that are on the map, in Alberta, at least?
16897 MR. TODD: Well, if you read the sentence after that --
16898 MR. LOWE: That is true. That is true, they may not all proceed, but we just don't know if they are going to proceed or not.
16899 MR. TODD: Well, what we know is that if prices stay up near the cap, you know, of 11 cents, we would like to see many of them coming onstream. As they bounce around those corporate decisions will be revisited. There is lots of time for them to make their -- or revise their decisions.
16900 Yes, it will depend upon market conditions, as any investment does. If they see sustained high prices, they will invest.
16901 MR. LOWE: Then as they invest they build these, say, baseload, mine mouth coal projects like the Minalta(ph) people you are familiar with, Mr. Matwichuk, and then that would provide lower cost power. That will trend the price down, it will trend the market price down as these projects come onstream?
16902 MR. TODD: Well, first of all, as I understand it, the business rationale for a lot of this development is for export purposes so a key driver is going to be the continental price and supply and demand conditions elsewhere. They are looking for increased intertie capacity, and these are drivers, as well as the domestic market. Again, all of it ties in as part of decision-making.
16903 The investors are a mix of corporations, but we are moving toward a more multinational-type basis where they are looking at supply and transmission on a continental basis. There are some good opportunities in terms of if you look at where Alberta is located, in terms of the marginal production of electricity, which is with coal and gas, it is cheaper to transport electricity than gas and oil supplies and coal. Therefore, essentially they are saying: Let's generate near the source of the fuel that creates the electricity and transport it over electrical grids across the continent.
16904 So it means a complex decision and I think it is inappropriate to be looking at the Alberta market specifically. The drivers will be much broader than that.
16905 MR. LOWE: It will be the North American market eventually that will set the price?
16906 MR. TODD: Yes.
16907 MR. LOWE: Thank you.
16908 MR. MATWICHUK: But, Mr. Lowe, there are some other complicating factors especially with respect to Alberta and that is the policy intervention. The reason a lot of these projects have been announced, and announced only, is that a lot of investors have come in to kick the tires, so to speak, and then have seeing the province change the rules of the game right in the middle of the game.
16909 So they have said: Well, look, if there is so much uncertainty with respect to the rules, I'm not so sure that I'm going to put the shovel in the ground. One of those is with respect to the 11 cent cap. The province has changed that cap once already, may change it again. There have been rebates, as you know, in Alberta directly from general revenues to residential customers.
16910 So those types of factors interplay with the general revenues and the oil and gas royalties. I mean, if oil and gas prices are high, then there is lots in the pot to play with. If they are low, then customers are going to be faced with higher prices and then there is going to be more of an outcry for supply to come onstream.
16911 So it really depends on a lot of other factors than just the price alone to drive investment.
16912 MR. LOWE: So you are saying that investors, if they perceive that there has been some changes in the deregulation process, some kind of retrogressive steps kind of thing, then they will just say: Well, look, we will go elsewhere. We are not going to put steel in the ground here. That is the phenomenon that you are talking about?
16913 MR. MATWICHUK: It is more of the uncertainty that is bred by those types of policy decisions.
16914 MR. LOWE: Thank you.
16915 Now turning to page 17. You have this? This is on to telecom --
16916 MR. TODD: Which document? Page 17 of Dr. Evans --
16917 MR. LOWE: The N-MAX document still. It is this heading "Energy, Services, and Fibreoptics". It talks about this Lightstream company that owns and operates 170 route kilometres of fibreoptic backbone in Calgary.
16918 Is Lightstream a CLEC?
16919 MR. MATWICHUK: I don't know.
16920 MR. LOWE: Okay.
16921 Does it have access to ducts and rights of way in the City of Calgary?
16922 MR. TODD: We are basing our comments just on what is here. Lightstream is currently enhancing the backbone to an optical ethernet in order to provide high-speed data connectivity to commercial customers. So it sounds like it is serving a very narrow and specific segment of the market.
16923 To do that, it presumably has access to some underground facilities, but that is pure speculation. I mean, if they are providing those facilities they have to have some place to put them. Presumably, they are not providing a general local distribution network, from the description here. But again, that is just based on the words we see here.
16924 MR. LOWE: Okay. That's fine. If you don't have anything else to add on Lightstream, I will move on.
16925 Do you have your response -- as everyone says, you don't need to turn it up but this is the ARC(BELL)4. It is where you say -- and I think you see this in some other interrogatories:
"The evidence presents the views and recommendations of Messrs Todd and Matwichuk. They have provided the following response `The views of ARC et al on all relevant issues will be provided in final argument'." (As read)
16926 I was looking at the ARC opening statement and it says at page 3 of 5:
"Rates are not just and reasonable when they are maintained at high levels in order to subsidize otherwise economic competition as proposed by CLEC." (As read)
16927 Are you gentlemen in disagreement with the opening statement on this point?
16928 You are not trying to concoct some kind of lifeline for CLEC's proposal behind the back of Ms Lawson or anything, are you?
16929 MR. TODD: Firstly, the opening statement was the statement of ARC et al. We were not part of that and this is -- we are just reading this now.
16930 Certainly, we are not trying to do anything on the backs of Ms Lawson. What she is doing, she will have to tell you for herself.
16931 Taking that statement as it is, from our perspective it is not just and reasonable that you maintain rates at a high level to subsidize otherwise uneconomic competition. It certainly would be inappropriate to achieve the goal, the Commission's goal of competition, by creating a scenario where you can have uneconomic competition. It would be no more sustainable than uneconomic bypass and it would not be good for customers, not good for the competitors, not good for the industry.
16932 MR. LOWE: Thank you, sir.
16933 Now, at paragraph 130 of your evidence, you seem to leave the door open a bit for some rate rebalancing of local services.
16934 As I read your paragraph 130, you say:
"There could be rebalancing occurring between cap services with rates that exceed costs and those that are below costs and also that it should further the Commission's objectives." (As read)
16935 Do you see that?
16936 MR. TODD: Yes.
16937 MR. LOWE: So your acceptance of rebalancing -- and I admit it is within those two tests -- it would avoid entrenching forever the existing system of internal subsidies in the rate structure. You are not saying: Let's cast the current structure in concrete and live with it forever, are you?
16938 MR. TODD: Our proposals do not envisage a price cap regime that will go on forever. Our proposals do not eliminate all pricing flexibility and say that here is a cap that must apply to every rate individually.
16939 Clearly, within our proposals there is room for some adjustments which we are referring to as rebalancing -- rebalancing not in the traditional sense of local to toll, obviously, but rebalancing, for example, within the non-high cost basket that we propose.
16940 So for example, if you look at rates versus PES costs, which the ratio, the margin, if you want, above costs that is realized by rates is in the order of 100 markup for Band A and goes down across the bands. We are saying if the Commission determined that it was appropriate to see some shifting in that, to get it close to cost recovery, some amount of rebalancing could be accomplished within the regime that we are proposing.
16941 MR. LOWE: Thank you.
16942 Well, those are my questions.
16943 Thank you, gentlemen.
16944 I'm sorry I had no questions for you, Dr. Roycroft.
16945 MR. TODD: He had his turn before the break.
16946 THE CHAIRPERSON: Thank you, Mr. Lowe.
16947 Mr. Secretary, perhaps we could number Mr. Lowe's exhibits.
16948 MR. SPENCER: Thank you, Mr. Chairman.
16949 I have seven documents.
16950 The first one is the TELUS response to Undertaking requested by BCOAPO. Transcript reference Volume 8, paragraph 12771, will be introduced as TELUS Exhibit No. 12.
EXHIBIT NO. TELUS 12: TELUS response to Undertaking requested by BCOAPO. Transcript reference, Volume 8, paragraph 12771
16951 MR. SPENCER: Response to Undertaking requested by GT Group Telecom. Transcript reference Volume 8, paragraph 13410, will be introduced as TELUS Exhibit No. 13.
EXHIBIT NO. TELUS 13: Response to Undertaking requested by GT Group Telecom. Transcript reference, Volume 8, paragraph 13410
16952 MR. SPENCER: Response to Undertaking requested by Commission Counsel Ms Moore. Transcript reference Volume 8, paragraph 13561, will be introduced as TELUS Exhibit No. 14.
EXHIBIT NO. TELUS 14: Response to Undertaking requested by Commission Counsel Ms Moore. Transcript reference Volume 8, paragraph 13561
16953 MR. SPENCER: Response to Undertaking requested by BCOAPO. Transcript reference Volume 9, paragraph 14697, TELUS Exhibit No. 15.
EXHIBIT NO. TELUS 15: Response to Undertaking requested by BCOAPO. Transcript reference Volume 9, paragraph 14697
16954 MR. SPENCER: N-MAX Information Summary, August 2001, will be introduced as TELUS Exhibit No. 16.
EXHIBIT NO. TELUS 16: N-MAX Information Summary, August 2001
16955 MR. SPENCER: We also have two CRTC Undertakings.
16956 The first one is CRTC Undertaking for the companies regarding X factor by company, will be introduced as CRTC Exhibit No. 35.
EXHIBIT NO. CRTC 35: CRTC Undertaking for the companies regarding X factor by company
16957 MR. SPENCER: Undertaking for TELUS regarding forecast X factor, CRTC Exhibit No. 36.
EXHIBIT NO. CRTC 36: Undertaking for TELUS regarding forecast X factor
16958 MR. SPENCER: Thank you.
16959 THE CHAIRPERSON: Thank you, Mr. Secretary.
16960 We will turn now to the next party to cross-examine this panel, CallNet.
16961 Mr. Koch.
EXAMINATION / EXAMINATION
16962 MR. KOCH: Good morning.
16963 My name is Michael Koch and I represent CallNet Enterprises. With Mr. Lowe's permission, I am going to ask you some questions about the telecommunications industry.
--- Laughter / Rires
16964 MR. KOCH: I don't have that much for you, but I would like to start with a few questions about your recommendations regarding the appropriate X factor for the second price cap regime.
16965 MR. TODD: Yes.
16966 MR. KOCH: As I understand it, under ARC's proposal, a price cap index would only be applied to residential services.
16967 Is that correct, Mr. Todd?
16968 MR. TODD: Yes. To be strict, I don't think ARC has a proposal yet. When they retained us, they retained the right to take whatever position they want --
16969 MR. KOCH: Oh, that's right.
16970 MR. TODD: -- final argument. So this is the Todd-Matwichuk proposal.
16971 MR. KOCH: My notes may say ARC's proposal, but --
16972 MR. TODD: So we will refer to it as our proposal.
16973 MR. KOCH: Okay. So on the transcript for "ARC", we can just read Todd-Matwichuk then.
16974 As I understand it, you are recommending an X factor well in excess of the 4.5 per cent previously applied. Correct?
16975 MR. TODD: That is correct.
16976 MR. KOCH: One component of that factor that you are recommending would be a stretch factor. Is that correct, Mr. Todd?
16977 MR. TODD: Yes it is.
16978 MR. KOCH: As I understood your evidence, that stretch factor would take into account the productivity gains achieved by the incumbent in relation to services -- in addition to those services which are capped also in relation to those services which are not capped. Is that correct?
16979 MR. TODD: You are including trying to find the wording, because the wording is different and it is an important distinction.
16980 MR. KOCH: The point I'm making is that in deriving your stretch factor you are not solely looking at the productivity gains achieved directly in relation to the cap services.
16981 MR. TODD: In fact, what we are looking at are the benefits that are derived by the ILEC that are attributable to the utility segment services. So in that sense we are talking about not only cost reductions, which is the traditional way we often think of productivity, but productivity actually involves other things such as increasing revenues in both directly -- part of the cap services but also in what I would call linked services.
16982 For example, there is non-capped services that they are able to sell and generate additional revenue by virtue of having a de facto monopoly in the cap service. So with limits, in terms of their being a relationship, yes, we are looking beyond the cap services themselves for the productivity gains, broadly speaking.
16983 MR. KOCH: I would like to move now to discussing competition with you, Mr. Todd.
16984 As I understand your evidence, you are in favour of maintaining a price cap on prices because you are sceptical that competitive forces can discipline the ILEC's behaviour. Is that correct?
16985 MR. TODD: Yes. Competition is not effective and our concern is that in the local residential market, that within the term of the price cap regime that we are probably talking about of, say, four years -- yet to be decided by the Commission -- it is not realistic to expect that there will be pervasive competitive constraints on the pricing by the ILEC, and, therefore they would have, in effect, what is often referred to as a quasi-monopoly, a near monopoly, during the price cap period, in which case they could use that position to generate excessive net income, excessive profits, which could be used, then, to sustain what we refer to as anti-competitive pricing in other areas, not being used in the Competition Bureau sense but in the sort of economics or practical market sense of being able to defeat competition by having the deep pockets of profits from other services.
16986 MR. KOCH: But your concern, Mr. Todd -- I don't think you and I are disagreeing -- is not that competition doesn't work if there is competition, rather your concern is that there won't be pervasive competition?
16987 MR. TODD: Exactly.
16988 MR. KOCH: Okay.
16989 MR. MATWICHUK: Mr. Koch, I think probably to try to articulate what's necessary is that there are really sort of two conditions. One is a competitive market structure, and that if a competitive market exists then that can lead to competitive market performance.
16990 MR. KOCH: Okay.
16991 At paragraph 26 of your evidence you note that long distance rates have indeed declined considerably. Is that correct?
16992 MR. TODD: I don't see the quote, but your statement is correct, yes.
16993 MR. KOCH: Yes. I take it you would agree that the consumers of long distance services have benefited enormously from this decline in long distance prices, have they not?
16994 MR. TODD: Yes. I would throw out the caveat that in the long distance competition hearing the ILECs were promising very significant reductions through rebalancing and cost efficiencies. So relative to alternative scenarios, it's not clear exactly what the benefits are, but certainly over time, to use the time variable that was talked about earlier this morning, over time there has certainly been significant savings enjoyed by customers.
16995 MR. KOCH: Okay. As you indicated, there were a couple of alternatives open to the Commission to bring about those savings, that the option the Commission chose was competition and competition has worked to bring those prices down. Correct?
16996 MR. TODD: Yes. They chose -- I think rightly chose -- competition, and have gone down that path and it has worked well in the long distance market.
16997 MR. KOCH: Now, you would agree with me that lower prices is not the only potential benefit of competition to consumers. Correct?
16998 MR. TODD: It's the primary benefit, but it's not the only benefit.
16999 MR. KOCH: Okay. Choice and innovation are often cited as other benefits of competition?
17000 MR. TODD: Yes. One of the interesting things is that with the move -- and I have been involved in the move to competitive markets in many different industries at this point -- with the move to competition, if your choice is between a bunch of different service providers at, say, a 10 per cent higher price than if you didn't have that choice, customers no longer are able to say "Well, I would rather not have the choice and have the lower price". So you don't actually see how much they value that choice.
17001 They are now choosing perhaps at the higher rates amongst competitors, and, yes, they, in a sense, benefit from that choice that they have, but we are not able to get evidence that they actually find those higher prices a fair trade-off for the greater choice.
17002 That i's where it comes back to looking at the underlying principles of: Is the competition economic or not? I think in long distance we are able to clearly conclude that the competition is economic. In the residential local market, it is far less clear. I think our judgment -- certainly my judgment is that the economic competition is several years away on a ubiquitous basis.
17003 MR. KOCH: But sticking with the market that we have some experience with, I take it you would agree with me that in the long distance market, in addition to having realized the benefits of lower prices, consumers have also received or realized the benefits of choice and innovation, for the most part?
17004 MR. TODD: I think customers have mixed views on that, to be frank with you.
17005 They have not enjoyed confusion. They have not enjoyed the difficulty in finding which is the best deal. But certainly when simple choices have been put in front of them, such as a fixed rate monthly plan, they have liked that.
17006 So some things they have liked, some things they haven't.
17007 MR. KOCH: Okay. One of the points you make about competition in your evidence, Mr. Todd, is that in a market characterized by effective competition one would not expect to see the kind of across-the-board results for the incumbents as have been experienced during the first price cap. Correct?
17008 MR. TODD: Yes. When you line up the positive, above normal returns of the ILECs and put that on one side of the sheet against the negative performance of the competitors, that in a normal competitive market if you saw that patterns amongst two groups of companies, you would say there is some competitive inequity there, some imbalance.
17009 MR. KOCH: And, in fact, if I could ask you to turn to paragraph 55 of your evidence, you state:
"We must conclude either that the ILEC of all the best managers in the industry and the competitors are populated with incompetent managers, which does not seem credible to us, or that the advantages of incumbency have awarded the ILEC an insurmountable competitive advantage, a proposition that seems far more credible." (As read)
17010 I take it another way of saying that, it is unlikely that all of the incumbents are managed in a superior fashion to all of the CLEC, correct?
17011 DR. ROYCROFT: Yes, we, of course, always prefer our way of saying it, but I think you are saying the same thing.
17012 MR. KOCH: Now, one of the difficulties you identify in your report facing new entrants, is the pricing flexibility enjoyed by the ILEC under the first price cap regime, correct?
17013 DR. ROYCROFT: Yes.
17014 MR. KOCH: And you are aware the incumbents are claiming in this proceeding that prices must be permitted to rise in order to assist competitive entry, but I am suggesting to you that their plans really don't guarantee price hikes as much as guarantee themselves more flexibility in the pricing, correct?
17015 DR. ROYCROFT: And that is exactly our point, in that a price cap does not force increases. We have seen that with existing price cap regime, where the companies for customer relations or for competitive reasons don't want to raise the prices. They are not forced to. Certainly once they raise their prices, if for competitive reasons they want to lower them again, they can. So we have to look at the incentives in the company under the flexibility that they envisage and the incentive would be to go to the max where they are not facing competitive challenges and go to the min where they are facing competitive challenges.
17016 When we look at the existing price cap regime, while the ILEC continually tell us that the decrease in business rates down to, in some cases, the floor of the invitation test have been driven by the price cap regime, the reality is they were choosing where to lower rates in order to meet the price cap constraint, and they were choosing not to lower residential rates.
17017 As it happens, their reductions coincide -- I am sure it is just co-incidental -- the reductions are right in the areas where the market is most competitive. They have not implemented reductions where the market was not competitive.
17018 I would expect to see the same co-incidence to occur in the future with increases and decreases of rates within the new proposed baskets.
17019 MR. KOCH: Dr. Roycroft, I take it from my reading of your report, that you would agree as well that incumbents are in a position to use -- where there isn't competition across the board, incumbents are in a position to use their pricing flexibility to harm competition?
17020 DR. ROYCROFT: Yes, the incentive structure that they would have would encourage them to use pricing flexibility in a way that would advantage them competitively.
17021 MR. KOCH: Now, Dr. Roycroft, at paragraph 55 of your evidence you address the evidence -- or rather the theory in which you give a title here "Accommodative entry theory", and you are asked the question, Dr. Taylor and Dr. Wiseman both argue that accommodative entry policies which reduce some costs may eliminate the need for retail regulation as long as input prices are regulated. Do you agree? And you say, no, the basic problem with Dr. Wiseman and Dr. Taylor's arguments that accommodative entry should lead to the elimination of retail prices is that their arguments substitute the existence of policy for the existence of competition as the basis for the decision of how to treat retail prices. It is a fundamental mistake to assume that the desired results of a policy naturally follow from the implementation of a policy. Rather what must be evaluated are actual outcomes that can be observed in the marketplace.
17022 When I read this I recalled Dr. Taylor's joke on the stand while I was cross-examining him that economists often say it works in practise but does it work in theory. That's what you are making reference to, that often theory and practise depart?
17023 DR. ROYCROFT: Absolutely. The challenge that policy makers face is the challenge of evaluating the policies and making adjustments to policies that are based on what is happening in the marketplace.
17024 As I indicate here a fundamental mistake to just set policies and then just assume that everything is naturally going to work out the way the theory behind the policy predicts.
17025 MR. KOCH: And in your evidence you go on to test Dr. Wiseman's model of accommodative entry policies by relaxing certain of the underlying assumptions. I would like to draw your attention to that, Dr. Roycroft.
17026 One of the assumptions that you seek to relax is that local loops are available at equal cost both to the incumbent and its rivals under accommodative entry policy.
17027 I would like to ask you to turn to paragraph 62 of your evidence.
17028 Do you have that, Dr. Roycroft.
17029 DR. ROYCROFT: Yes, I do.
17030 MR. KOCH: Here you say, it is appropriate to test this model -- that is Dr. Wiseman's model -- by relaxing some of the unstated assumptions. The first assumption to relax is that the bottleneck input, the local loop, is available at equal cost both to the incumbent and its rivals. An important real world consideration is whether the incumbent can impose transaction costs on its rivals when provisioning the local loop or other bottleneck inputs.
17031 And you go on to say, that in the U.S. -- and I am paraphrasing here -- these transaction costs have been a major consideration for the FCC and it has really tried to grapple with the whole issue of operations support systems -- in other words, the mechanisms under which incumbents can transfer a loop to arrival, correct?
17032 DR. ROYCROFT: Correct.
17033 MR. KOCH: And so, even if the accommodative entry policy appears to create an equal or level playing field in terms of the cost of the loop, there are still these additional issues that may, in fact, tilt the playing field against arrival, correct?
17034 DR. ROYCROFT: The pricing of a loop may not reflect the total cost of acquiring that loop to the rival.
17035 MR. KOCH: Now, at paragraph 64 -- and so I guess what we are doing there is we are testing, again, the theory, which is that you create these policies and all of a sudden everyone is on an equal playing field. You are testing that with the practise that there is more to it than that, correct?
17036 DR. ROYCROFT: That is correct.
17037 MR. KOCH: At paragraph 64 you deal with another assumption that you seek to relax. You say, "Another unstated assumption in Professor Wiseman's model is that customers incur no cost in switching providers or alternatively that the entrant faces no cost of customer acquisition."
17038 Here you reflect the fact that customer acquisition costs are yet another burden, if I could put it that way, on the rival side of the ledger that doesn't have the same impact on the incumbent side of the ledger, is that correct?
17039 DR. ROYCROFT: Correct, and customer acquisition costs may reflect simply customer inertia, they don't want to deal with the customer choice issue or they maybe cultivated by the incumbent from the standpoint of incumbents locking in customers in the long-term contracts that have breach penalties which would tend to encourage the customer to stay put.
17040 MR. KOCH: Now, in paragraph 69 -- I know this is the concluding paragraph because it is the paragraph that precedes -- does this conclude your prefiled testimony? Yes, it does.
17041 And you say here:
"If price cap regulation were nevertheless suspended in response to accommodative entry policy alone, regulators should guarantee the flow-through of efficiency gains that arise within the monopoly and put-market environment by frequently updating input prices to account for any changes in technology that improve the efficiency of the incumbents operations." (As read)
17042 Now, in the event that retail prices are not regulated, therefore, I take it, your evidence is that it is vitally important to ensure that prices competitors pay for inputs reflect all possible efficiencies in the incumbent's operations, is that correct?
17043 DR. ROYCROFT: That is correct.
17044 MR. KOCH: And one of the effects of passing on all possible efficiencies to competitors, is that these efficiencies are likely to be reflected in the prices competitors will charge for their services, is it not?
17045 DR. ROYCROFT: Correct.
17046 MR. KOCH: And, therefore, absent a regulatory mechanism such as a price cap index, effectively only competition stands a chance of passing on the incumbent's productivity gains to the consumers, is that not correct?
17047 DR. ROYCROFT: Correct. If you take away the price cap regulation scheme, then, competition would be the only constraint left.
17048 MR. KOCH: Thank you.
17049 Those are my questions, Mr. Chairman.
17050 THE CHAIRMAN: Thank you, Mr. Koch.
17051 I believe that, then, is all parties who indicated an intention to cross-examine this panel.
17052 So we will turn to Commission Counsel Moore.
EXAMINATION / INTERROGATOIRE
17053 MS MOORE: Thank you, Mr. Chairman.
17054 I would, first, like to just explore with you a few questions relating to reporting requirements in the next regime, and if you could turn to The Companies evidence at paragraph 4-22, please.
17055 "In this paragraph with respect to the possibility of a earnings sharing overlay, the companies have indicated in part that to avoid unwarranted regulatory intervention in those markets where competition has taken route it would also be necessary to exclude these services from the financial results to be considered in an earnings review.
17056 If these competitive areas were not excluded, earnings regulation could give the regulated firm an advantage over its competitors. If the firm's earnings were lowered as a result of pricing or other practices in the competitive market, then earnings regulation applied to the broad base of services both competitive and non-competitive would permit the subsidization of competitive offerings by non-competitive offerings."
17057 So I wonder if in your view if an earnings sharing mechanism were to be implemented by the Commission, do you agree with the companies assessment that it would be necessary to exclude the more competitive services from the utilities segment?
17058 MR. MATWICHUK: If an earnings sharing, Ms Moore, was undertaken and that begs the question of what kind of reporting can be used to justify the earnings sharing is I think where your going and when you are -- the starting point as far as I understand the split rate base is the audited financial statements of the company and if -- when we get into split rate base, if when we divide up between the utility and the competitive segment there still has to be some kind of accountability, some kind of reporting check and balance to ensure that the two components make up the whole and that the split is appropriate.
17059 So as to whether the competitive segment should be reflected in the public results, I guess that is a question that I would leave to the Commission, unless Mr. Todd has a comment on that aspect of it.
17060 But I think what you are faced with is certainly the Commission has to have access to all parts of the whole.
17061 MR. TODD: One of the advantages of having a panel is that while Mr. Matwichuk was talking I was able to flip back and read a bit more of the context -- review it.
17062 I think that in this section the companies have been smudging the line or a distinction between earnings regulation and earnings sharing.
17063 In my view earnings sharing is not earnings regulation and the difference is that earnings regulation and the paragraph you were reading about were statements -- would say earnings regulation, not earnings sharing and, although the section, if I am looking back, the section is talking about earnings sharing and that is where it gets smudged.
17064 Earnings regulation is forward looking in terms of what the expected revenues are going to be and costs are going to be and rates are set based on a forecast of costs.
17065 Earnings sharing does not do that. And if you go back to paragraph 417 there is reference to a earnings sharing plan whereby allowable price limits are increased if the regulated firms returns are below the earnings threshold carries with it the potential of any missteps in decision making the regulated firm can be made up.
17066 Now, the implication here is that if they make a bad decision and they are earning below their allowed return that on a going forward basis rates are raised.
17067 I think that is a bit of a mischaracterization. If they earn below the return then that shortfall is shared with the customer. Yes, that is, in a sense, an adder to the return next year, but that is not an adjustment to the base rates on a going-forward basis. You would still have a price cap regime under an earnings sharing mechanism determining the base rates.
17068 Therefore, what it does is exactly what the Commission said earnings sharing does in its first decision, it lessens the dollar impact on the company, but it does not hold them whole with respect to missteps. There remains a penalty to the shareholder for underperforming and a benefit to the shareholder for overperforming.
17069 Therefore, the incentive is still there, directionally, but I think that the comments that you referred to -- the paragraph 422 -- I would say is applicable to earnings regulation, but not to earnings sharing.
17070 MS MOORE: Thank you.
17071 Now, as you are probably aware, The Companies are proposing that Phase 3 split rate base results no longer be required by the Commission. I wonder if you have any comments on whether it would be appropriate, if there is no earnings sharing mechanism, for example, to replace that type of reporting with some form of financial reporting on a total company basis.
17072 MR. TODD: On a total company basis. I presume by that we are talking Bell Canada, for example, we are talking Bell Canada, not BCE.
17073 I think you are talking -- there is a lot of problems with that concept, in that then you do not know what's happening in the utilities segment versus the competitive segment, or versus other segments.
17074 One of the concerns that we have expressed in our evidence is that, under the proposals of The Companies, the earnings in the utilities segment, particularly for cap services, but, more broadly, for the utilities segment generally -- because removing the cap on business services will also create opportunities in more remote areas where there may not be business competition -- generally, those earnings could go way up. If you are only looking at a total corporate basis, those high earnings could be used to offset very low returns in competitive areas.
17075 From a practical perspective what may well be going on is that The Companies, the ILECs, could be using the strategy to keep the overall return at a level that is acceptable to shareholders, retains their ability to attract capital, keeps managers getting their bonuses because they are meeting their targets, but at the same time is making the competitive markets price so low that the competitors are driven out of it and that's the issue of remonopolization.
17076 If you are only looking at a corporate basis, you would be unable to identify those kinds of what we have referred to as cross-subsidies. They are not technically cross-subsidies in the economic sense, or may not be, but what it is is making high profits in non-competitive areas and using those to fill the deep pockets which are then emptied in the short run to gain market share or regain control of competitive areas, and then down the road increase the profits, because now they have total control of all aspects of the industry. It can also be used, in effect, to subsidize or support entry into other areas, Internet services provision or whatever.
17077 Therefore, we are concerned that you must have reporting on a utility segment basis so that returns in that segment can be kept within reasonable bounds so that there is some discipline on the company to also seek reasonable returns in other business areas.
17078 MS MOORE: Are there any other concerns that you would have with total company reporting or does that cover your major concern?
17079 MR. TODD: For me, that's enough.
17080 MS MOORE: If you could now turn to paragraph 153 of your evidence. This is where you discuss price cap for residential baskets.
17081 MR. TODD: Yes.
17082 MS MOORE: So you say:
"The price cap for each residential basket, both high-cost and non-high-cost, of capped services should be constrained to increase by no more than inflation minus productivity, similar to the current price cap where productivity is significantly higher than the current 4.5 per cent figure." (As read)
17083 Now, generally speaking, if the rate of inflation were lower than the productivity offset, ILECs would be required to reduce residence rates?
17084 MR. TODD: That's right.
17085 MS MOORE: I wonder whether it's your view that the price cap constraint that you propose on the residence sub-basket should allow for residence rates to be reduced below the incremental costs of providing the service.
17086 MR. TODD: Let's be careful on definitions here. In particular I will refer to discretionary services, because discretionary services are intimately tied to the basic service. I cannot go to Bell for my basic service and go to somebody else for the discretionary services.
17087 First of all, we look at the basic service as a package. It is not really just discretionary services but there is a package of revenues that go with it. We refer to that as the total customer value concept in the evidence.
17088 It is not in the evidence per se, but I would say and I think we would say that the price or the revenue for what is, in effect, the revenue that is related to that basic service -- so for example including average earnings from discretionary services -- should not fall below marginal cost, plus a reasonable markup. An imputation test could be applied on that basis.
17089 Frankly, I think it would be inappropriate and inconsistent with the competitive market analogy to apply a constraint that says basic service in isolation could not fall below the marginal cost, Phase 2 costs. In other industries, we see products which are, you know, lost leaders.
17090 In effect, basic service is the tie to the customer that brings in revenue, and the revenue brings in quite literally is not the fee for basic service, it is the package of revenues. In making economic decisions, the way companies operate in non-regulated markets is, they say "I want the customer, if I can make money on the customer". Marketers talk about off-selling and cross-selling and that type of thing.
17091 So from that concept, that clearly should be a lower constraint.
17092 MS MOORE: Now, if we were to have a rule that said just with respect to the basic service elements that that rate element shouldn't fall below incremental or Phase 2 costs, and we didn't accept your comments relating to the role of discretionary services in that package, what --
17093 MR. TODD: I think that would be the first time the Commission rejected my comments!
--- Laughter / Rires
17094 MS MOORE: -- what would the harm be, in your view? What would be the consequence of that?
17095 MR. TODD: Again let's take it down one level.
17096 If it was applied on, should we say, a band-specific basis, and if you are using, for example 25 per cent markup, you could get into the situation where essentially that rule would be forcing rate adjustments between Bands A, for example, and Bands C or D.
17097 Now, if it were the Commission's policy objective to ensure that in no band do prices fall below Phase 2 costs, that might be a reasonable thing to do.
17098 If, however, the Commission's view of the policy objectives, telecommunication policy objectives in the Act is that bands should not be used for pricing in that way, that we should have that forced price difference across non-high-cost bands, but for example companies should be permitted to have one rate across all bands which on average is compensatory, then it would be inappropriate. You could have an undesirable, from a policy perspective, outcome.
17099 You have to look at the implications of the rule.
17100 If the rule were applied on an aggregate basis to the revenues and cost for the non-high-cost basket, if you want, then it probably wouldn't be a serious problem. Given where rates are right now, frankly, in our proposal, and the expectation that Phase 2 costs will be declining, I don't think would be a relevant constraint. It would not have any impact on pricing over the term of the price cap regime we are talking about. So from that perspective it wouldn't be a concern.
17101 MS MOORE: Thank you.
17102 Now, elsewhere in your evidence -- I'm referring to paragraph 142, but I don't think you need to return to it.
17103 But in general terms you propose that there be separate baskets with a particular price cap formula applied separately to each basket. So you propose a basic residential service basket in high-cost areas, a basic res service basket in non-high-cost areas and basic business services.
17104 In light of what you mentioned earlier about the role of discretionary services, I just want to clarify whether with respect to your basic residential services baskets would optional services associated with those services be themselves capped? Would the formula apply, in that sense?
17105 MR. TODD: The way our evidence deals with that issue is that it says there is a relationship between the productivity offset and the capping of discretionary services. It doesn't say that explicitly, but implicit in the discussion.
17106 So that, for example, if you were to cap discretionary services, which would be reasonable to do on the grounds that basic service has sort of grown for many people to include certain discretionary services -- I know that for my mother, she can't have a telephone without call display. She just doesn't want the phone to ring unless she knows who is calling, so for her it's integral. So it may be reasonable on a policy basis to say that this now should be viewed as a package and all that should be taken into account.
17107 As The Companies rightly point out, that may limit the potential for generating additional revenues through discretionary services. However, they still have increased penetration rate as an opportunity to increase the average revenue per NAS from those services, and they have potentially increased number of services being sold to customers, new packaging and so on, so there is still the significant opportunity to increase those revenues, but there would be, at least notionally, a lower productivity target because there is less opportunity for the company to achieve benefits.
17108 Frankly, I suspect if you just capped the rates, included them in the cap, would be a modest impact, probably a rounding error in terms of productivity offsets because we talk about half percentages. It is going to be 4.5 or 5 or 4, not 4.5 or 4.55. So it is probably not relevant in an overall basis. But what we are saying is there are trade-offs and there is a balancing in making the call on what the appropriate productivity offset should be and that is a relevant consideration.
17109 MS MOORE: So do you have, at this point, a firm recommendation for the Commission on whether optional local should be capped as part of the basic residence basket?
17110 MR. TODD: We, as economics economists and accountant-type perspective, say there is no economically right or wrong answer to that. It is a policy choice. I'm sure the clients will speak to that in terms of what they feel the correct policy choice is and the Commission should decide on the grounds of policy choice, in my view, not the basis of economic efficiency, because it is not really an economic efficiency issue.
17111 MS MOORE: Thank you.
17112 MR. TODD: The answer, then, is no, we don't have a position because it's a trade-off. That's all we can say.
17113 MS MOORE: Thank you.
17114 If you could turn to Volume 7 of the transcript, please. I will also be referring to your paragraph 47 at page 10 of your evidence.
17115 MR. TODD: We don't have 7 here.
17116 MS MOORE: I can probably read to you the passage --
17117 MR. TODD: Okay.
17118 MS MOORE: -- that I'm interested in.
17119 This is just relating to --
17120 MR. TODD: I'm sorry, what paragraph was that again? We now have a copy of the transcript.
17121 MS MOORE: I will be referring to page 1752.
17122 MR. TODD: We are there.
17123 Thank you.
17124 MS MOORE: At line 11162.
17125 Now, the context of this, I was discussing with Mr. Hariton a statement that you had made in your evidence with respect to the provincial income tax not being fully reflected in the rate of inflation. So at line 11,162, Mr. Hariton stated:
"But the point is that, yes, maybe there is going to be a tax cut in Ontario one year. There will be tax cut in Alberta another year. Another year, another province is going to do something. In another year, another province will do something else. So you will have a series of province-specific events. By and large they do cancel out and we feel comfortable in using a national inflation measure to capture inflation province by province."
17126 So I was wondering if you could comment on that view and whether you still take the position that provincial taxes are not fully reflected in the Canada-wide inflation?
17127 MR. TODD: The link is distant. I mean, I don't think it's black or white.
17128 Dr. Hariton is not incorrect in his statement. There is a flowthrough. Things can happen over a period of time.
17129 What we are concerned about is that we are not looking here at the long run. We are looking at setting a price cap regime for four years that will -- in our view, in order to further the goal of enhancing competition and in order to fulfil the objectives of balancing interests of customers and shareholders, that it is appropriate that what should be in the minds of the Commission, in our view, is that the result should produce a normal rate of return with normal performance by the companies.
17130 Therefore, a factor such as the taxes, which has a very significant and immediate impact in terms of The Companies' financial performance, that may flow through through the inflation factor over a period of time but it will take, you know, similar actions in other provinces and it will take a flow-through from the tax rates to the cost of goods and services, and to customer prices. That is a long way off.
17131 Then, the flowthrough is not guaranteed, it is a matter of market conditions, that that is a prescription for leading to the high returns that we are concerned about and the impact that those high returns are likely to have on the financial flexibility of the company to exploit that advantage over the competitors and maintain their dominance of the market and expand it.
17132 So the bottom line of that is, there is truth in what he says, but in terms of our goals here in terms of setting a price cap regime, I think those considerations are far too remote to override explicit consideration of the tax effects. We disagree.
17133 MS MOORE: So do you recommend that the Commission move to looking at province-by-province tax cuts, looking at that specifically?
17134 MR. TODD: Well, there are clear differences in TELUS itself between B.C. and Alberta. There are significant differences.
17135 Earlier this morning, I believe it was with Mr. Lowe, we were talking about, in effect: Should we be looking at changes in the contribution regime? The issue was: We are going into a new price cap regime, should we be looking forward to changing some circumstances?
17136 Our view is that it would be inappropriate to only look at things that have a negative impact on The Companies and ignore things that have a positive impact on them. If changes are taking place which will affect the financial performance in the next cap period, we should be looking at all of them. We should be looking at a change in the contribution regime and the impact on The Companies but we also should be looking at the tax effects. We also should be looking at the fact that the returns over the past four years have been depressed by significant investments in restructuring which will go away and on a going-forward basis returns will be different.
17137 We should be looking at the fact that there has been shake-out in competition in the business market and the long-distance market. What the normal cycle of competition is that initially you have oversupply, you have a lot of competitors coming in fighting for market share, what is often referred to as price wars. So in the short term we see prices that are very, very low. That leads to low profits, that leads to a shake-out in the industry, and the consequence of that is that then profits and prices tend to rise. We have seen that in many industries.
17138 So another consideration in terms of change is that we have seen the disappearance of many competitors, we have seen a lessening of competition in terms of numbers of competitors and over the next price cap term we are likely to see higher prices and profits in other services, in some of these other competitor services, some of which, business services, have been in part in the utility segment.
17139 MS MOORE: Thank you.
17140 One last area of questioning.
17141 You mentioned the concept of normal rate of returns and elsewhere the phrases like "super normal profits" are used. How does one determine what normal rate of returns are, on the base of what theory, on the base of what data?
17142 MR. TODD: This regulator is very familiar with the strict methods which were part of the rate base rate of return approach. We are not suggesting going back to having Dr. Morin and others come in here with their textbooks and having a hearing to determine the rate of return.
17143 What we are looking at is a much more high level analysis that the approved rate by the Commission for the current price cap regime was 11 per cent. In general, Long Canada's have gone down since the time of that decision, so you could be looking at lower returns. Perhaps there are some adjustments that would be appropriate for competitive factors, but you are talking, you know, maybe a 100 basis points off.
17144 So when you take a look at returns in the area of 16 or 18 or 20 per cent, I don't think you have to get a precise normal return, that is to the first decimal place in the percentages.
17145 What we are talking about is reporting such as we have seen in this proceeding the split-base results, looking at what we think is going to happen to those on a going-forward basis, and making a judgment as to whether they seem to be exceptionally high. Strictly speaking, and many specialists may say you should have a rate base of return hearing to determine a new number and use that as a reference point. We are not advocating that.
17146 We are saying that, you know, use reason to say: Are we 300 or 400 basis points above what would be recognizable? Is this an ambiguous high return?
17147 Perhaps a simple way to look at it is just looking at ILECs versus CLECs. You know, there is a bias in the marketplace. Relative to the industry average they are having extraordinary performance with no clear indication of any superior management -- with all deference to the ILECs -- but rather it being attributable to differences in the regulatory and market structure, the mere fact of incumbency.
17148 MR. MATWICHUK: Ms Moore, I would echo the comments of Mr. Todd and just suggest that to search for the data, the data is readily available. There are formulas available. National Energy Board and British Columbia Utilities Commission use such formulae. Again, I don't think we are looking to peg a particular rate. This Commission is very familiar with setting a reasonable range.
17149 I think the reporting is essential to establish going forward from the benchmark, how it would compare to that benchmark. The reporting that we have seen in this proceeding is fine to a point, except what we don't know is how they actually get from audited financial statements to the split-rate base, particularly when we see -- I think it was in the case of TELUS anyway, where we see the split-rate base results changing based on actual data from 2000. We have seen, I think, two or three renditions of the split-rate base results.
17150 Clearly, there is an incentive to demonstrate a lower rate of return and unless there are checks and balances on that, and they can be of various types, we don't know whether the returns are being reported accurately.
17151 MR. TODD: We should be very clear on the purpose too, because the numbers you need depend on the purpose.
17152 We are not proposing identifying an appropriate rate of return and adjusting rates to generate that return.
17153 What we are talking about is looking directionally as to what the appropriate productivity level is. And if returns are high and going to be going higher, and that is a concern, that indicates that the productivity is too low, the productivity factor is too low.
17154 So we are looking at, on a going-forward basis, do we need a productivity factor that results in rates going up as the companies propose by inflation or 3 per cent a year or should we be looking at a productivity factor similar to what we have in the past of 4.5 per cent or more, which may lead to some rate reductions, particularly in light of a removal of constraints on the business market.
17155 So the kinds of caps we are talking about in this proceeding under The Companies -- when I say "The Companies" is both Telus and The Companies -- proposals, they are saying we remove the constraints on the business services so rates can go up and we let local rates go up. We know directionally what impact that would have on the ROEs.
17156 Therefore we thought we should be looking at, from an excessive return basis, you don't need an exact number to say we can support more productivity than that.
17157 I think the debate this morning about the U.S. situation, about the 6.5 and the U.S. just kept going to courts and there is big battles over it, how do you justify it? It is interesting to contrast the American way of doing things with the British way of doing things.
17158 The American way of doing things is that if you don't explain exactly how you got your number, you end up in court.
17159 Oftel explicitly and directly uses judgment. I come to the Commission and I say really when you look at these issues, and speaking to your issue of what is an appropriate return, I think the only realistic way to approach it is the Oftel way, which is we look at it and use judgment and say: Is what we are seeing and what we expect to get reasonable? Is it excessive or not? Rather than try to go the American way, because of its judicial regulatory system, of trying to pin down a number based on historical data in order to set a productivity going to the future, I believe in judgment.
17160 MS MOORE: Thank you.
17161 Those are my questions, Mr. Chairman.
17162 THE CHAIRPERSON: Thank you, counsel.
17163 Just one question, I think, Dr. Todd.
17164 In discussion with counsel you mentioned, I think, that if we were to consider simply the basic residential rate under a basket we shouldn't allow the rate -- assuming the X factor is greater than the rate of inflation -- we shouldn't allow those rates to fall below marginal cost.
17165 Now, if we include options and features in the basket -- you may be aware that in the contribution decision we deemed a certain amount of revenue per NAS for the purposes of defining the magnitude of the total subsidy requirement -- how would you handle that issue, then, in terms of how low you would allow that basket to shrink?
17166 Because I took it from your comment on paragraph 130 that ideally you feel we should be trying, as much as we reasonably can, get the subsidies out of the system.
17167 MR. TODD: First of all, let me deal with that last point, which is that I don't see it as a policy goal to get the subsidies out of the system.
17168 The policy goals are addressed appropriate rates in high cost areas. And as long as costs are above what are, from a policy perceptive appropriate rates, then, it follows that there must be a subsidy and I see no reason to squeeze the subsidy out as long as the subsidy is consistent with those policy objectives.
17169 With respect to the non-high-cost areas, and I think we are talking -- and I am aware of the treatment of the optional services -- and I think you are referring to in the basket for the non-high-cost areas how would they be treated and I like the target revenue approach because it does create incentives.
17170 What the cap would do would be to cap the price they can charge per optional service, but you could leave an incentive around the market penetration. The companies would have an incentive to get more people, to sell optional services to more people, they would have incentives to get people to buy more and that would be part of achieving greater productivities, but they would not then be able to take advantage of people being hooked, if you want, on those services and jack the prices up to increase the revenues.
17171 THE CHAIRPERSON: But how do we ensure that the revenue doesn't fall below and, therefore, start driving the total subsidy requirement back up again?
17172 MR. TODD: Okay. So now we -- now we are talking about the high-cost areas?
17173 THE CHAIRPERSON: We are talking about the revenue that is derived that we have deemed --
17174 MR. TODD: Okay. So they could as an option, they could in their discretion reduce the rate they are charging for the optional services?
17175 THE CHAIRPERSON: Well, under your model, I take it, if we cap the options and features along with the rate itself, we could end up shrinking the revenue coming from that basket.
17176 My question to you is how do we ensure that that doesn't shrink to a point where we are in fact increasing the subsidy requirement and, therefore, increasing the per cent that we need to require for the subsidy fee, if you will?
17177 MR. TODD: To respond to that question, we have to separate between non-high cost areas and high-cost areas because they are different baskets.
17178 In the non-high cost areas what we envisage is that the cap would be applied but there would be a separate decisions by the CRTC which could be designed to increase rates and offset the rate by a reduction contribution and, in effect, the Commission could decide, for example, that for high-cost areas the overall rate should not be reduced and the subsidy would be -- decline over time through the productivity gains in the high-cost areas.
17179 So that there is kind of adder of rebalancing between rates and contribution in the high-cost areas. Is that too confusing?
17180 THE CHAIRPERSON: Yes.
17181 MR. TODD: Okay. What I am suggesting is that -- Okay. We could go back a step. The principle underlying the proposals is that the price cap should be designed to reflect trends in target costs.
17182 So if we say that costs should be declining over time to the starting point rates should be declining over time by roughly the same amount. And if the company has exceptional performance and gets costs coming down and additional revenues, other benefits that exceed target, then they benefit and if they don't achieve the target then they loose and that principle of linking the price cap formula to reasonable trends and costs would apply to both baskets.
17183 There is a separate policy issue of contribution. As an overlay to declining prices in the high cost areas, the Commission may say that but wait a minute now from the affordability perspective, from the perspective of the rationales for contribution, it would be appropriate that rather than having rates go down, we keep rates flat, for example, and reduce contribution.
17184 But I can't make that recommendation as an economist, because that is a policy decision in terms of an adjustment to the keeping prices in line -- the underlying prices in line with costs. You, as a Commission, may decide that in high cost areas rates should be flat, they should go up by inflation. That is purely a policy choice. We cannot -- there is no economic principles to say what should be done there.
17185 So that is why I have separated the two price effects in high cost areas. One is the rebalancing between contribution and the rate and the other is having the underlying rate going with -- reflecting costs.
17186 To make it more simple you may simply say, let's freeze rates in high cost areas and we will take all of the productivity benefits and use those to reduce contribution -- and that would be totally consistent with what we are recommending.
17187 Okay. In the non-high cost areas we are saying you maintain that relationship. If optional services are included, then, that package of services would be going down, but by definition because the decline in cost is corresponding to decline in -- sorry, decline in rates corresponds to decline in costs and benefits being realized, that would be the starting off compensatory that stay compensatory -- as long as the company achieved the target productivity.
17188 THE CHAIRPERSON: Okay. Thank you very much.
17189 I believe those are all the questions, then, for this panel.
17190 I thank you very much, gentlemen, for your participation in our proceeding.
17191 So we will take our lunch break now, then, and reconvene at 1:30 where, I believe, AT&T Canada is the next party up.
--- Upon recessing at 1228 / Supension à 1228
--- Upon resuming at 1332 / Reprise à 1332
17192 THE CHAIRPERSON: Order, please, ladies and gentlemen. We will return to our proceeding now.
17193 Before we do, are there any preliminary matters?
17194 I will just mention that we have had a couple of requests to provide an opportunity to use teleconferencing for several parties from out west to be able to do their oral final argument. We are certainly prepared to do that. The Secretary will arrange for the teleconferencing facilities to be made available for next Monday.
17195 With that, we will turn to the next party to be cross-examined, AT&T Canada.
17196 Mr. Ryan.
17197 MR. RYAN: Thank you, Mr. Chairman.
17198 Good afternoon.
17199 The two gentlemen and the lady before you are presented on behalf of AT&T Canada.
17200 Sitting in the middle of the panel is John McLennan, who is the Vice-Chairman and CEO of AT&T Canada. He is also director of a variety of other companies, Chairman of the Cape Breton Growth Fund and Chancellor of the University College of Cape Breton.
17201 On his left is David Lazzarato. Mr. Lazzarato is the Executive Vice-President of the company and its Chief Financial Officer.
17202 On Mr. McLennan's right is Theresa Muir, who is the Vice-President, Regulatory Affairs of AT&T Canada.
17203 Mr. Chairman, the CVs have been previously filed and can be found as AT&T Exhibit No. 1.
17204 In the back-up panel, the two ladies, starting with the right of the panel, are Sharon McNabb, and on the left-hand side of the panel, Irene Sobol. They are both employees of the company. In the middle is Bernie Lefebvre, who is a consultant based in Ottawa.
17205 The witnesses are ready to be affirmed, Mr. Chairman.
17206 THE CHAIRPERSON: Thank you.
AFFIRMED: THERESA MUIR
AFFIRMED: JOHN T. McLENNAN
AFFIRMED: DAVID A. LAZZARATO
17207 MR. SPENCER: Thank you.
EXAMINATION / INTERROGATOIRE
17208 MR. RYAN: Starting with you, Mr. McLennan.
17209 You have seen your CV as filed as part of AT&T Exhibit No. 1. Is that CV accurate?
17210 MR. McLENNAN: Yes, it is.
17211 MR. RYAN: That same question to you, Mr. Lazzarato.
17212 MR. LAZZARATO: Yes, it is.
17213 MR. RYAN: And to you, Ms Muir.
17214 MS MUIR: Yes, it is.
17215 MR. RYAN: Ms Muir, do you have a copy of the evidence of the company as filed on the 20th August 2001 in front of you?
17216 MS MUIR: Yes, I do.
17217 MR. RYAN: Was that prepared by you or under your direction?
17218 MS MUIR: Yes, it was.
17219 MR. RYAN: The company has responded to a series of interrogatories, including interrogatories dated 31st of August 2001.
17220 Were those responses prepared by you or under your direction?
17221 MS MUIR: Yes, they were.
17222 MR. RYAN: Is that evidence, and are those interrogatory responses true, to the best of your knowledge and belief?
17223 MS MUIR: Yes, they are.
17224 MR. RYAN: Mr. McLennan, you have a copy of the evidence in front of you as well, do you?
17225 MR. McLENNAN: Yes, I do.
17226 MR. RYAN: Have you reviewed it?
17227 MR. McLENNAN: Yes, I have.
17228 MR. RYAN: Is it true, to the best of your knowledge and belief?
17229 MR. McLENNAN: Yes, it is.
17230 MR. RYAN: Mr. Lazzarato, you have a copy of the evidence before you?
17231 MR. LAZZARATO: Yes, I do.
17232 MR. RYAN: Have you reviewed it?
17233 MR. LAZZARATO: Yes, I have.
17234 MR. RYAN: Is it true, to the best of your knowledge and belief?
17235 MR. LAZZARATO: Yes.
17236 MR. RYAN: The witnesses are available for cross-examination, Mr. Chairman.
17237 THE CHAIRPERSON: Thank you, Mr. Ryan.
17238 Welcome, Ms Muir, Mr. Lazzarato, Mr. McLennan.
17239 This is probably an unusual situation, I almost turned to Mr. Henry to introduce you, Mr. McLennan, thinking of some of your past history.
17240 We will turn, then, to the first party to cross-examine, that being The Companies.
17241 Mr. Henry.
17242 MR. HENRY: Thank you, Mr. Chairman.
17243 I am assisted this afternoon by Al Wallace, of Bell Canada.
EXAMINATION / INTERROGATOIRE
17244 MR. HENRY: Good afternoon, panel.
17245 I would like to start by asking you to turn to your opening statement if you could, please. I think that is AT&T Exhibit No. 2.
17246 MR. HENRY: Do you have that?
17247 Before I turn you to the specific paragraph, let me start by making sure we are all on the same page here.
17248 I understand AT&T is proposing that CLECs would receive a 70 per cent discount on all utility segment services provided by the ILECs to the competitors. Is that correct?
17249 MR. McLENNAN: No, that is not what we are proposing.
17250 We are proposing that we be able to acquire services from the ILECs at the same cost that they themselves incur to access those services in the competitive marketplace.
17251 MR. HENRY: Is that not a 70 per cent discount off retail rates?
17252 MR. McLENNAN: It is a restructuring of the prices that we currently pay when you accumulate all of the services together by approximately 70 per cent.
17253 MR. HENRY: If the price is $100, what do you pay?
17254 MR. McLENNAN: Excuse me?
17255 MR. HENRY: If the retail price is $100, what would you pay?
17256 MR. McLENNAN: If the retail price is $100 --
17257 MR. HENRY: What would AT&T pay?
17258 MR. McLENNAN: According to our new basket, or our new proposal?
17259 MR. HENRY: Yes.
17260 MR. McLENNAN: It would be in the neighbourhood of 70 per cent less.
17261 MR. HENRY: Thirty dollars?
17262 MR. McLENNAN: Thirty dollars.
17263 MR. HENRY: Can we go to page 2 of your opening statement.
17264 In paragraph 2 the second sentence, I just want to make absolutely sure I am clear on what this means.
17265 It says:
17266 That is Facilities-Based Carrier rate.
"...rate does not represent a subsidy from the incumbents to the competitors, as has sometimes been claimed by the incumbents. On the contrary, AT&T Canada's proposal will in fact ensure that in aggregate incumbents receive the incremental cost of supplying their facilities." (As read)
17267 I want to reread that sentence with a couple of additions and ask you to tell me if it is true.
17268 The last sentence I read:
"On the contrary, AT&T Canada's proposal will in fact ensure that in aggregate incumbents recover from competitors the incremental cost of supplying their facilities to competitors." (As read)
17269 Is that what you mean by that?
17270 MS MUIR: Yes, that is what we mean, in aggregate. We are looking at our aggregate purchase of service.
17271 MR. HENRY: Aggregate competitor services.
17272 MS MUIR: That is correct.
17273 MR. HENRY: Right. Is your conclusion about that based on your calculation of the 70 per cent discount, the Table 5-1 calculation?
17274 MS MUIR: Just before you say "our conclusion", it is not a 70 per cent discount. I think that has already been clarified.
17275 We are talking about the prices in aggregate for the services we pay would be 70 per cent less than what we would pay today for the aggregate basket of services.
17276 And, yes, our conclusion does come from our Table 5-1.
17277 MR. HENRY: Why do you say: We haven't established that that is a discount?
17278 MS MUIR: Well --
17279 MR. HENRY: Let me ask the question again: If there is something that sells for $100, what are you going to pay for it?
17280 MS MUIR: Actually we wouldn't apply the rate we are proposing to an individual item. What we are proposing is that you take the basket of services that we purchase to provide service to the end customer -- so the basket of services that competitors come to you for -- so that they can provide service to the end customer. In aggregate, the 70 per cent discount would be applied to that whole basket of services.
17281 MR. HENRY: Let me ask it this way: Let's suppose next year you buy exactly the same number of services from us at the same prices, then you add one more service at $100. How much do you pay for that one more service at $100?
17282 MS MUIR: I would have to look at in aggregate what I have spent with you this year, add the $100 and apply the 70 per cent.
17283 MR. HENRY: So if you spent a million dollars with me this year and next year you bought something that retails $100, would you pay one million one hundred dollars or one million thirty dollars?
17284 MS MUIR: If I spent a million dollars with you this year I would be paying a million less 70 per cent next year. So then I would be paying a million one hundred less 70 per cent.
17285 MR. HENRY: And on the 4100 you would be paying 4100 less 70 per cent.
17286 MS MUIR: If I only bought one service, but that is not what we are talking about.
17287 MR. HENRY: Okay.
17288 As I understand it, this proposed 70 per cent discount is supposedly intended to reflect the implicit cost of network services supplied by ILECs to themselves. Is that correct?
17289 MS MUIR: That's right. What we are trying to replicate is the advantage the ILEC has. So "replicate the cost", the ILEC actually pays implicitly when they provide the same services to end customers that we provide.
17290 MR. HENRY: You calculate this supposedly by using AT&T's own cost structure of its own network as a proxy for the ILECs cost?
17291 MS MUIR: Yes. What we did was actually try to figure out how come there was such an anomaly in terms of what the ILECs were actually earning and what the ILECs were charging to competitors and how come there was so much disparity between the two.
17292 We looked at the ILECs' financials in aggregate and then we looked at our financials in aggregate and the costs we were actually spending with the ILEC. Looking at those two things we couldn't reconcile the fact that the ILEC purports to basically be at cost or below cost for a substantial portion of the revenue they accrue in their utility segment, are providing competitor services purportedly at cost, and yet are able to generate huge profits from that particular segment.
17293 Having examined the problem for a while we thought: Well, what if we look like an ILEC and we were able to build our network out the way the ILEC had built their network out so we would have a ubiquitous territory under which we could provide service, how much would it cost us to supply ourselves with that service? That is what our model --
17294 MR. HENRY: Can we look at how you derived that.
17295 I would ask you to turn please to Table 5-1, on, I believe, page 35.
17296 MR. HENRY: Do you have that?
17297 I want to focus on the second line and see if I understand how you have done this.
17298 As I understand it, you currently pay $421 million -- and that is in the left-hand column, second row -- to the ILECs. That is called "ILECs cost of goods sold".
17299 MS MUIR: That's right.
17300 MR. HENRY: That is an AT&T number, not a total CLEC number.
17301 MS MUIR: That's right. These are all AT&T numbers.
17302 MR. HENRY: Just before I understand these numbers better, the 421 is made up of the 304 and the 117. Those add together. Correct? 304 plus 117 equals 421, right?
17303 MS MUIR: I'm going to take your word for it. I can't do that in my head.
17304 MR. HENRY: All right. Maybe you can do this one in your head.
17305 The arithmetic to get the 70 per cent discount is simply 304 divided by 421. Is that how I get it?
17306 MS MUIR: That's right, yes.
17307 MR. HENRY: The 421, as I say, consists of these two lumps. Let me refer to them as "two lumps". I don't want to understand what is in them.
17308 As I understand it, the 117 reflects interconnection costs, terminating costs, things of that nature, that AT&T would still have to pay if it served all of its customer base with its own facilities.
17309 MR. LAZZARATO: Mr. Henry, I think I would like to be the third party on this panel to reject the notion of the word "discount". I know you keep using it, but just so it is unanimous here.
17310 In terms of the 304 and the 117, those are not two separate baskets. I think you are implying that we are willing to continue to pay for certain things and not pay for certain others and that is not the way we have constructed our model at all.
17311 MR. HENRY: I haven't got there yet, but I think we have established that 421 equals 304 plus 117, and I just want to understand -- I think you describe it in your evidence. I didn't think this was controversial.
17312 The 117 are the things that you would continue to buy if you served all of your customer base with your own facilities. I am not talking about a discount yet, I'm just talking about 117 was what you presumed you would still pay if you used your own facilities. Isn't that what you said in your evidence?
17313 MR. LAZZARATO: That's right. One-seventeen is what we presumed we would still pay. That's right.
17314 MR. HENRY: And the second lump, the 304, reflects services that AT&T currently purchases from ILECs, and mostly services that are not classified as essential or near essential, things like digital network access, Centrex, and so on. Is that correct? That is what the 304 is. And that is what you have assumed you would not pay if you had your own network.
17315 MS MUIR: Some of them, yes.
17316 MR. HENRY: Some of them what?
17317 MS MUIR: Some of them are the services you mentioned. They are the services that we would be able to provide ourselves if we had our own network.
17318 MR. HENRY: Right. I calculate that about 90 per cent of those are non-essential or near-essential -- non-essential or non-near-essential.
17319 MS MUIR: Ninety per cent?
17320 MR. HENRY: Right.
17321 MS MUIR: I would have to actually check it out. How did you calculate that?
17322 MR. HENRY: I think it was about 284 million. In one of your other interrogatories you had shown Centrex and PRI and DNA and so on and I got a figure of about 268 over 304. Perhaps you could say "subject to check".
17323 Is it common ground that at least the vast majority of these are either non-essential or non-near essential?
17324 MS MUIR: That we would say. Yes, most of them are access services that we purchase from you that fall into that category.
17325 MR. HENRY: Your theory is that if you served all of your customers with your own facilities you would not need to purchase this second lump of services of 304. So then you say that the 304 is approximately 70 per cent of the 421, and that is how you derive the discount. Correct?
17326 MS MUIR: I guess the only thing is, it is a mix of things, some that we would not have to purchase, and some, like parts of switching an aggregation, we made specific assumptions as to what would happen with those services.
17327 MR. HENRY: But the 304 --
17328 MS MUIR: The 304 would include some savings, in switching and aggregation, for example. If we had a ubiquitous network -- we made a fairly conservative assumption there -- but if we were you, Bell Canada, we would be able to actually originate and terminate calls on our own network, never really paying switching and aggregation back to you, for example.
17329 MR. HENRY: So the switching and aggregation, as I understand it, some of it is in the 304 and some of it is in the 117, representing the fact that you believe that in the 117 there is some switching and aggregation that you would continue to have to pay if you were on net, and in the 304 there is some switching and aggregation which you would not have to pay. Is that correct?
17330 MS MUIR: That's right.
17331 MR. HENRY: So the whole 304 are all the things that you would not have to pay if you were on net.
17332 MS MUIR: That's correct.
17333 MR. HENRY: So viewed another way, you would be billed by the ILEC $421 million, less a 70 per cent factor. So what number would the ILEC receive from AT&T? It would be the net amount of 117, wouldn't it?
17334 MR. LAZZARATO: That's right.
17335 MR. HENRY: In other words, the ILEC under your proposal would receive 117 million, which is equivalent to the lump A we talked about. Is that correct?
17336 MS MUIR: The "lump A"?
17337 MR. HENRY: The lump A was 117 and the other lump was the 304. We get the 117.
17338 MS MUIR: That's right. You get some of it.
17339 MR. HENRY: No, we get all of it. We get 421, less 70 per cent --
17340 MS MUIR: You, Bell Canada, get some of it.
17341 MR. HENRY: I'm sorry. you're right. I'm speaking for "we" the ILECs collectively.
17342 Can we now turn to AT&T(CRTC)3206 please. But don't put away that Table 5-1, I will be coming back to it.
17343 MR. HENRY: AT&T(CRTC)3206 and I am going to be going to page 3. At line 8 we see the same numbers we were just looking at. My understanding is there is a 424, 304, 117 and you have broken down, in lines 2 to 7 above line 8, exactly how you computed each of those lumps, if I can call it that. Is that correct?
17344 MR. LAZZARATO: That's right.
17345 MR. HENRY: If we look at the makeup of the $304 million savings, we see, starting from the top, that you have DNA service that you currently pay $160 million for. That is in column 1. Correct?
17346 MR. LAZZARATO: That's right.
17347 MR. HENRY: In column 2 you assume that if you served all your customers with your own facilities you would save $160 million. In other words, you would pay zero. That is the dash that is reflected in column 3. Correct?
17348 MR. LAZZARATO: I agree with the first part of your statement, that if we had an ubiquitous network like yours, or another ILEC, we wouldn't incur those costs.
17349 The extension of "and therefore we area paying nothing for that", I choose to look at it in the aggregate for those services, Mr. Henry.
17350 MR. HENRY: But under your proposal you would still buy these DNA services from the ILEC. Right?
17351 MR. LAZZARATO: We would still buy all of the services noted by these line items, 2 through 7, that's right.
17352 MR. HENRY: And you just assume you won't pay for them?
17353 MR. LAZZARATO: No, we have assumed we will pay a different amount.
17354 MR. HENRY: Well, you will pay 30 per cent. Is that correct?
17355 MR. LAZZARATO: We will pay the costs that we estimate --
17356 MR. HENRY: You will pay 30 per cent with the -- MR. LAZZARATO: -- we would incur to provide ourselves those kinds of services incrementally.
17357 MR. HENRY: Right. So you will pay 30 per cent of lump A, 30 per cent of lump B, and we will get 117. I think we are agreed on that.
17358 MR. LAZZARATO: Yes.
17359 MR. HENRY: Then if we go down one more line to line 3, we see Centrex. We see that again you are paying $85 million for Centrex, and you assume that if you served all your customers with your own facilities, you would save $85 million and that you would pay zero to the ILEC. Again, I said: If you served all your customers with your own facilities, you would save $85 million and pay zero to the ILEC". Isn't that true?
17360 MR. LAZZARATO: Again, if we had a network ubiquitous like yours we would not incur those costs for a separate stand-alone service, that's right.
17361 MR. HENRY: Column 6, PRI, same thing, right? You pay $23 million for a PRI today and you assume you would save $23 million on your own facilities and that you would pay zero the ILEC.
17362 MR. LAZZARATO: That's right.
17363 MR. HENRY: In column 4, Switching and Aggregation -- Ms Muir just alluded to that -- that one you split out an assume that you would still pay 51 to the ILEC, and you would save $21 million if you had your own network. Correct?
17364 MR. LAZZARATO: That's right. In that switching and aggregation is usage-driven costs would not be totally replaced.
17365 MR. HENRY: Right.
17366 MR. LAZZARATO: I will go back, if I may, on your Centrex question and say that further along on this analysis we have been very balanced and where we would incur additional costs by operating that network ourselves, i.e., that ubiquitous network, we have added in the costs of that.
17367 MR. HENRY: I am going to come to that in a moment.
17368 But just before we leave this, if we went through all of the lines down to line 7, you similarly calculate in column 3 how much you would pay the ILEC, and that is how you get the 117 million that we talked about earlier, and the 304 in the middle column of savings that we talked about earlier. Right? So that is the makeup.
17369 MR. LAZZARATO: That is how we get the difference between the 421 and the 117. That's right.
17370 MR. McLENNAN: Just in terms of replacing costs, some of the costs are actually replaced in lines 1 to 7. So moving Centrex we would actually add costs to line 7.
17371 MR. HENRY: Line 7 is "Other"?
17372 MS MUIR: Yes. EAS trunks, for example. We would have increased our costs there.
17373 MR. HENRY: That would represent some of the 44?
17374 MS MUIR: Yes. I don't have that in front of me, but I am assuming that 44 is in the far right-hand column.
17375 MR. HENRY: Right, it is.
17376 MS MUIR: The assumptions actually go through each service and decide how much we pay to you would be eliminated in totality if we were to use our own network to provide the service.
17377 So there is a little more detail behind each line than just: We will wipe it out and there are no other cost.
17378 For example, when we wipe out Centrex we realize we will be carrying more traffic on our own network, therefore we would have to have more trunk.
17379 MR. HENRY: I want to come back to something Mr. Lazzarato just said I think. Again, don't put away Table 5-1 and 3206, we will be coming back to them.
17380 If you could go to paragraph 5-10 on page 34 of your evidence, please.
17381 You say there that:
"The financials for the comparison of AT&T Canada hybrid and on-net operations were derived based on an assumption that all of The Companies' existing customers would be serviced on AT&T Canada's own network facilities." (As read)
17382 And then:
"Payments to ILECs for services and facilities to offer local dedicated and dial-up internet, as well as to augment AT&T facilities were eliminated." (As read)
17383 These savings were somewhat offset by the additional on-net costs, including provisioning costs, such as on-net per line cost, additional operating expense for staff, materials and maintenance, rights of way, and building access.
17384 The savings that were offset by these extra costs, is the extra cost the $66 million that is shown in column 2 back on Table 5-1?
17385 MR. LAZZARATO: That's right.
17386 MR. HENRY: It's the second last number in column 2.
17387 As I understand it, that $66 million represents the extra operating costs you would incur based on serving your customer base with your facilities in high density areas and it doesn't reflect the ILEC's cost of serving its entire territory in any event, does it?
17388 MR. LAZZARATO: I think I agree with that.
17389 I would reiterate what Ms Muir just said a moment ago, in that in the items in lines 2 through 7, where we have replaced with our model some of the services we purchase from ILECs with our own services, there are some incremental costs added back in lines 2 through 7. They are not separately identified there as the 66 is separately identified.
17390 MR. HENRY: But these are your own operating expenses here, aren't they? The 66 million is your own operating expenses?
17391 MR. LAZZARATO: That's right.
17392 MR. HENRY: I thought the stuff we were talking about a minute ago with Ms Muir was other things that you would still have to buy from us.
17393 MS MUIR: We were. We were talking about other things.
17394 MR. HENRY: What I want to know is, where in the heck did this $66 million get figured into the 70 per cent discount? You said you offset the savings by the additional costs and, for the life of me, when I do the calculations I can't see how the $66 comes into the 70 per cent discount.
17395 MS MUIR: Actually, what primarily the $66 million is made up of are increased access costs associated with rights of way. That accounts for about $38 million of those costs. The other $21 million we had was for increased national network staff.
17396 After looking at the majority of them, that would account to close to 60 of the 66.
17397 We felt that those were not costs that the regional ILEC actually incurs, or had incurred in the past, so in looking at their costs of self-supply we did not think we should necessarily deduct those costs.
17398 MR. HENRY: So the sentence on 5-10 that we just read is wrong? These savings were somewhat offset by the additional on-net costs. They weren't offset.
17399 MS MUIR: Offset for us.
17400 MR. HENRY: But not offset when you calculated the 70 -- they play absolutely no role in the 70 per cent discount?
17401 MS MUIR: That's correct. But I explained to you why they played no role.
17402 MR. HENRY: Because the ILECs would have no operating costs for any of the stuff?
17403 MS MUIR: No. The ILECs have operating costs just like we have operating costs, but we already have a network in place. We have already spent $2 billion on local network.
17404 What we are suggesting to you is if you have a similarly situated ILEC who spent $2 billion, like Manitoba Tel, their cost structure doesn't look like our cost structure.
17405 MR. HENRY: I guess you are suggesting that they have no maintenance costs to serve these customers.
MS MUIR: No, I don't think you are quite understanding what we are trying to get at, because what we are getting at is the cost for the ILEC when they provide service to the end customer, the cost of supplying that service to the end customer. We want to pay that cost to the ILEC. It is the cost of self-supply the ILEC actually incurs when they go out to the end customer. The ILEC doesn't go to somebody else to purchase parts of access, because they actually have the whole network.
17406 MR. HENRY: You said your costs were a proxy for the ILEC's cost.
17407 MS MUIR: That's right. So what we did --
17408 MR. HENRY: Bearing in mind that you have a network that is served in different areas, it is not as ubiquitous, but now you conveniently assume that the ILECs don't have any costs for these things that you have costs for.
17409 MS MUIR: No. The only two things we didn't assume -- because here were puts and takes. So from an operating perspective, since we already have built a network and we already have some of our customers on-net, we have some idea of what it costs to serve a customer on our network.
17410 So all we are saying is, if we were able to have our network ubiquitous in one territory and over the timeframe that the ILEC built their network up, where they would gradually expand their network and consistently achieve returns on that investment year after year, our cost structure would look different and that is what our cost structure would like.
17411 We are not saying we don't have any cost of serving.
17412 MR. HENRY: Where would I find, for example, the additional capital-related costs of serving customers entirely with your own facilities? I don't see any on that table.
17413 MS MUIR: But in terms of capital, we have invested capital of, let's say, $2 billion --
17414 MR. HENRY: Now you have assumed that you are going to serve these additional customers with your own facilities. Where's the capital costs of serving them?
17415 MS MUIR: With $2 billion, I'm pretty sure you could serve 440,000 customers on a ubiquitous network.
17416 MR. HENRY: So you have assumed no additional capital costs?
17417 MS MUIR: Actually, what we looked at was if we weren't in a growth mode -- and probably Mr. Lazzarato could add to that -- but if weren't in a growth mode, we would only be augmenting our network for natural growth. So we looked at our expenditures, and incrementally the spend wouldn't be that much greater
17418 THE CHAIRPERSON: Excuse me, Mr. Henry, this sound is as bad as it has ever been -- worse. I know the repair people are trying to fix it. I know it's difficult for us to concentrate in listening and it has to be difficult for the panel to concentrate. So I'm going to suggest we adjourn for a few minutes while the maintenance folks try and get these things fixed.
17419 MR. HENRY: Certainly, yes. Thanks.
--- Upon recessing at 1409 / Suspension à 1409
--- Upon resuming at 1411 / Reprise à 1411
17420 THE CHAIRPERSON: That's probably about the fourth or fifth time during the hearing that we have had that problem.
17421 MR. HENRY: The secret seems to be that we adjourn and it gets fixed.
17422 THE CHAIRPERSON: If I had known it's just simple to fix, I would have just knocked that thing on the wall earlier.
17423 Please, go ahead, Mr. Henry.
17424 MR. HENRY: Thank you.
17425 Okay, back to AT&T(CRTC)3206, page 3.
17426 I want to understand the nature of each of the ILEC services that you have used to compute the discount. Again, we just talked about lines 2 to 7 that reflect the makeup of ILEC cost of goods sold, and I want to start with line 2. That's called DNA service.
17427 Now, can you tell me is that service is used entirely for your basic local exchange voice, business?
17428 MR. McLENNAN: Do you know what I would like to do for just a second before we continue with the detail is to perhaps put this whole conversation in context a little bit, because the bigger picture, I think, help us sometimes get to the detail, which is what we have jumped into right away, without understanding what it is our proposal really addresses.
17429 What we believe strongly is that the ILECs have a dramatic competitive advantage over new entrants. I will bring it right around to your questioning, Mr. Henry, on the detail, but what we are fighting for here with our proposal, and what we are addressing, is a complete lack of competitive neutrality in the cost structure going into this competitive environment. It is a complete fact that there is tremendous advantage of scale to a pre-existing, high-fixed-cost ubiquitous network, with reach to essentially 100 per cent of all customers, already achieving extraordinary returns -- 16 per cent going to 20 per cent if the local rate increases are in fact approved -- and this dramatic advantage in the marketplace over new entrants --
17430 MR. HENRY: Mr. McLennan, this has nothing to do with the questions I have been asking.
17431 MR. McLENNAN: No, but what it does is it really sets up --
17432 MR. HENRY: It may do, but I ask the questions.
17433 MR. McLENNAN: -- the environment to get us to the detail. We are really diving straight into the detail of our proposal, but I think the purpose --
17434 MR. HENRY: Mr. Chairman, that's my prerogative.
17435 MR. McLENNAN: -- for this report is really important.
17436 THE CHAIRPERSON: As Mr. Henry indicates, Mr. McLennan, it is his prerogative. AT&T will certainly get an opportunity to put this in context, either later on in the questioning, and certainly in the argument stage.
17437 MR. McLENNAN: Thank you, Chairman. I think it will be helpful when we do that.
17438 MR. HENRY: Now, I think it's going to be helpful to understand the details so that we can then assess the overall impact.
17439 So I would like to start with these lines, "DNA", on line 2. Can you tell me, is that DNA service used entirely for your basic local exchange voice business?
17440 MS MUIR: No, not entirely. I guess it's used for access, in general, for either Internet services or voice services. But we are always --
17441 MR. HENRY: How about long distance? Is some of it used for long distance to terminate for originating -- to provide local interconnection for the purpose of originating and terminating long distance traffic?
17442 MS MUIR: Not for switched access, no. It might be used in some cases for dedicated access.
17443 MR. HENRY: For the long distance business? For DALS?
17444 MS MUIR: It could be, yes.
17445 MR. HENRY: How about for providing the local portion of an interexchange private line service, where you use your own interexchange facilities?
17446 MS MUIR: Yes, it would probably be used for the local --
17447 MR. HENRY: How about your data business?
17448 MS MUIR: Yes, I have mentioned our data.
17449 MR. HENRY: How about for your Internet business?
17450 MS MUIR: I beg you pardon?
17451 MR. HENRY: Your Internet business?
17452 MS MUIR: For my data or Internet business?
17453 MR. HENRY: Right.
17454 MS MUIR: Yes, it's actually done. It's all local access.
17455 MR. HENRY: Okay.
17456 MS MUIR: So any access portion for any of those businesses.
17457 MR. HENRY: How much of it is used for your basic local exchange voice business? Can you give me a percentage?
17458 MS MUIR: No, I can't give you a percentage.
17459 MR. HENRY: Is it small?
17460 MS MUIR: I couldn't tell you, actually.
17461 MR. HENRY: You can't give any order of magnitude? How much does your local business make up of your revenues? Isn't it about 13 per cent?
17462 MR. LAZZARATO: Yes, it's approximately 13 to 15 per cent, Mr. Henry.
17463 MR. HENRY: Your long distance business, about 44 per cent?
17464 MR. LAZZARATO: That's approximately right, that's right.
17465 MR. HENRY: Your data business, about 31 per cent?
17466 MR. LAZZARATO: Sounds familiar.
17467 MR. HENRY: Wouldn't most of these things be used for that business and not your local business?
17468 MR. LAZZARATO: I don't have a split in front of me at this point.
17469 MR. HENRY: Okay, let's go to line 4, switching and aggregation.
17470 Is this service used at all for your local exchange voice business?
17471 MS MUIR: Is it used for the local business, was that your question, sorry?
17472 MR. HENRY: The local exchange voice business?
17473 MS MUIR: No, switching aggregation is not used --
17474 MR. HENRY: It's used entirely for long distance, right?
17475 MS MUIR: That's correct. But it's all to get to the public switched network. All these switched services are actually to get local --
17476 MR. HENRY: How long have you been competing in the long distance business?
17477 MS MUIR: Pardon me?
17478 MR. HENRY: How long have you been competing in the long distance business?
17479 MS MUIR: Since 1992.
17480 MR. HENRY: Yes. And how long in the data business? Since about 1979? Okay, thank you.
17481 MS MUIR: I just want to clarify, though, that really what you are talking about is the access to the public switched network. So even though you are talking about different businesses, like data or long distance voice, the piece parts we are actually talking about here are gaining access to the network that the incumbents have for the local portion of that network, which we don't have.
17482 MR. HENRY: Stuff you have been buying for years -- 10 years, 20 years in some cases?
17483 MS MUIR: Right.
17484 MR. HENRY: Okay. How about PRI, what is that used for? Is that used, in some cases, for you LD or data business?
17485 MR. LAZZARATO: It's certainly used -- outside of the local area it's used on the Internet side.
17486 MR. HENRY: And for you frame relay business?
17487 MR. LAZZARATO: Probably a little bit, Mr. Henry.
17488 MR. HENRY: Is any of it used for your basic local exchange voice business?
17489 MR. LAZZARATO: Yes.
17490 MR. HENRY: How much?
17491 MR. LAZZARATO: I don't have a percentage off the top of my head.
17492 MR. HENRY: Pretty small, again?
17493 MR. LAZZARATO: I'm sorry, I don't have a percentage off the top of my head.
17494 MS MUIR: Actually, if you turn to 4200, our response to CRTC 4200 --
17495 MR. HENRY: I have, actually, and that's where I got most of this information from. It seems that there is hardly a mention of many of these things being used for your local exchange voice business, and that's really what prompted these questions.
17496 How about on line 7, "Other"? I see you have a footnote there. "Other" includes per call, toll-free dips -- toll-free dips would be the long distance business. Is that correct?
17497 MS MUIR: Yes, that's the 800 database.
17498 MR. HENRY: LDDA would be the long distance business?
17499 MS MUIR: Just a second. Just even it on the 800 database, the reason that the long distance carriers even require to dip into your database is because the incumbent has at least 97 per cent of that market.
17500 MR. HENRY: I wonder if you could undertake to tell me how much of lines 2 to 7 are used for your local exchange voice business versus your other businesses?
17501 MS MUIR: Sure.
17502 MR. HENRY: Okay. Thank you.
17503 Just so we are clear, it's how much of the $304 million that you would save is used for businesses other than local exchange voice business?
17504 MS MUIR: Can you just repeat that, sorry?
17505 MR. HENRY: Of the $304, which is all the things that you would save and that you would get a discount on, as I understand it, how much of them relate to your local exchange voice business?
17506 Just before we leave this 3206, I was interested in the below-the-line stuff. And I know it doesn't make up the 421 and 304 and 117, but number nine, for the life of me I couldn't figure out what "ILEC non-impact" meant. Could you tell me what that is? I notice in the abridged version you called it something entirely different. I think it was "non-ILEC carriers" or something.
17507 MS MUIR: What's there is contribution and some forborne services. In order to look at just the regulated service that we purchase from you, we removed that. So we said that they wouldn't be impacted as part of this savings.
17508 MR. HENRY: How about line 11? What is that, "lease transport"?
17509 MS MUIR: Those are network augments, ILECs transport. It could be purchased from you. We are just not asking you to reduce the price on that.
17510 MR. HENRY: Could it be purchased from other wholesale carriers?
17511 MS MUIR: In some cases, although, by and large, it's purchased from you. There aren't really a lot of other wholesale carriers out there. Occasionally, you might be able to get some transport from another carrier.
17512 MR. HENRY: And how about number 12, "forborne other carrier services"? That could be ILEC forborne services or services from other non-ILEC carriers?
17513 MS MUIR: They are probably ILEC carriers, just not the ILECs here. But they could be other carriers, as well.
17514 MR. HENRY: Not the ILEC carrier.
17515 MR. HENRY: Not the ILEC carrier. All right, thank you.
17516 MS MUIR: Telebec, QuebecTel.
17517 MR. HENRY: Oh, I see. All right, thank you.
17518 Now, I was intrigued when you came up with this discount and took 304, divided by 421. It occurred to me that if any other CLEC had done this exercise, based on their numbers, they might come up with quite different analysis, mightn't they?
17519 MS MUIR: They might. I guess what you have to do is step back and look at what we were trying to do. Basically, what we were saying is, today, in order to provide the same services that you compete with us on to the end customer, we purchase a group of services from you. Here's the mix between our on-net and off-net. And in order to be able to compete with you on a level playing field, we would estimate that if it were to cost us 70 per cent less to provide these services, if we were similarly situated, that we could reduce our mix off-net by that amount.
17520 Perhaps if somebody has a different network or purchases more from you, and had spent also the same amount of money on a network, it might look somewhat different. I didn't do the analysis, but it looks from CallNet's numbers, it wouldn't want to look that different.
17521 MR. HENRY: But you haven't done that?
17522 MS MUIR: No, I haven't.
17523 MR. HENRY: What struck me was kind of the arbitrariness of this. If any other CLEC had done it, you might have had a 90 per cent discount or a 40 per cent discount. I mean, it's very much dependent on the mix of services you buy. What rationale is there for applying a 70 per cent discount to all CLECs when everybody has different mixes of services, different business strategies?
17524 MS MUIR: What we are trying to actually get at is really your cost of self-supply.
17525 MR. HENRY: How do you know your costs are the best estimate of our costs?
17526 MS MUIR: Actually, they are the only costs we can actually look at. We are an operating company. There is no reason to believe that your costs are very different from our costs, and if they are different in any way there is a lot more reason to believe they should be lower as opposed to higher, just because of the ability you have had to grow your network in a certain way.
17527 MR. HENRY: And the ability we have to serve the whole province through to the north rather than concentrating in major cities?
17528 MR. McLENNAN: We would be delighted to go through a detailed overview of your costs. We would be delighted.
17529 MS MUIR: But actually, if you just turn to 3202 and you look at all the financials of the incumbents, you see that really by and large there has to be a huge advantage in ubiquity. If you turn to 3202, the attachment at the back. Irrespective of what kind of territory you serve it is between 40 and 50 per cent for all the incumbents.
17530 MR. HENRY: We are come to the EBITDA, don't worry. I promise you I will there.
17531 MS MUIR: But that is basically the rationale.
17532 MR. HENRY: Okay. Well, we will come to that and we will see if you have done it correctly.
17533 Tell me, if the Commission were to reduce the markup on essential and near-essential services to 15 per cent, how would that affect this calculation of the 70 per cent? Would it still be 70 per cent?
17534 MS MUIR: Probably, yes.
17535 MR. HENRY: Probably.
17536 MS MUIR: Well, I don't think it will have very much effect. If you look at a basket of services and you are talking about taking maybe 4 per cent of that basket of services and reducing that by a very small amount of money, I don't think it would have a huge impact on how much savings there would be associated with your cost of self-supply.
17537 MR. HENRY: Okay. Thank you.
17538 Now, we saw how you derived the discount on 3206. That was how you derived the discount.
17539 I just want to make sure when you apply the discount -- I wasn't entirely clear what services. So I just want to go through some services and ask you if the discount would apply to it or not.
17540 Switching and aggregation, you used it to compute the 70 per cent discount. Would you apply the 70 per cent discount to the switching and aggregation?
17541 MS MUIR: Actually, it would be a lot simpler if you just looked at our response to 3200. If you are looking at that's ATTC(CRTC)31Aug-3200 it has a list of all the services that discount would apply to.
17542 MR. HENRY: Do you remember if switching and aggregation is one of them?
17543 MS MUIR: Yes, it's there.
17544 MR. HENRY: Okay. Again, I think we have established that is used entirely for your long distance business, the local access portion of your long distance business. And it's applicable to 800 database query?
17545 MS MUIR: Well, really it is applicable to everything that was in the competitor services basket.
17546 MR. HENRY: Right.
17547 MS MUIR: And additional services that we have added. I don't know that you have to actually go through each service there.
17548 MR. HENRY: Well, I just want to make sure what they are used for as well.
17549 MS MUIR: Actually, I think we established what they are used for, though. They are used -- it is the local access portion of all the services we provide.
17550 MR. HENRY: Okay. All the services you provide, okay.
17551 Some of these services are currently provided by GT and other groups, Videotron and other companies like that? Some of the services you would get the 70 per cent discount are already subject to competitive supply?
17552 MS MUIR: I'm not sure exactly what services you are referring to.
17553 MR. HENRY: Well, some of these services DNA to connect local points in the network, local channels, the various things that are in the local network are competitive --
17554 MS MUIR: But do we purchase them from somebody else?
17555 MR. HENRY: Well, for example, Mr. Dixon filed an undertaking the other day that said two-thirds of the facilities provided between a collocated site and a CLECs pops were self-supplied.
17556 MS MUIR: That is supplied by myself, though, I think, as opposed to I would purchase it from somebody else.
17557 MR. HENRY: Well, you may not purchase it from somebody else. Are you aware that they are competitively supplied by people like Group Telecom and others? You are not aware of that?
17558 MS MUIR: No. Actually, I'm not sure exactly what you are referring to.
17559 Are you just talking about fibre that runs between my collocated space and my switch?
17560 MR. HENRY: Well, let's take DNA that can be used to provide the local portion of an interexchange private line service when you use your own IX facilities. Is there any other choice for that?
17561 MS MUIR: There may be.
17562 MR. HENRY: But did you hear Mr. Dixon say he bought from GT?
17563 MS MUIR: I'm not sure. Does he buy DNA from GT? Like that is just not what -- I'm just not clear what exactly Mr. Dixon buys from GT.
17564 MR. HENRY: Well, the fact is then you tell me you don't know. There could be some competitive supply, but you don't know.
17565 MS MUIR: Excuse me, I personally may not know.
17566 MR. HENRY: Does anybody on the panel know?
17567 MR. LAZZARATO: I think the one thing that is pretty clear, Mr. Henry, is if you are talking about a company like us having broad access to competitive supply from the competitive segment itself, I don't think the competitive segment is big enough to provide that broad supply.
17568 So certain small distance demand may be satisfied from someone else, but not broadly. I think that would be misgeneralization.
17569 MR. HENRY: Now, in Interrogatory 3208 -- perhaps you could turn to it.
17570 In that interrogatory at the bottom you say:
"The FBC rate is designed to foster sustainable competition in the facilities-based provision of local exchange services. Therefore, AT&T Canada proposes that only CLECs would qualify for the FBC rates." (As read)
17571 Then if you turn to 3200, page 2, if you could. You have that?
17572 The first full paragraph on the page. This one really intrigued me. It says:
"All of the services included in AT&T Canada's proposed competitor services basket are critical to an entrant's ability to compete with the ILECs in the local exchange market." (As read)
17573 Now, tell me, if the FBC proposal is designed to foster competition for local service, local exchange service as you say, and only CLECs would be eligible, why on earth would the discount apply to a service used only to provide long distance service, for example?
17574 MS MUIR: It actually would apply to all the services.
17575 MR. HENRY: Many of which are provided --
17576 MS MUIR: To ILEC.
17577 MR. HENRY: Let's take switching and aggregation.
17578 MS MUIR: Okay.
17579 MR. HENRY: It is supplied only for long distance. Why would the discount apply to that if this is designed for local exchange competition?
17580 MS MUIR: Well, I guess the way we looked at it, the reason we cut it off at CLECs -- because we argue, actually broadly, we are only talking about a cost of self-supply. We are also talking about fostering local competition. I guess I find the two connected. They are integrated.
17581 MR. HENRY: Well, that statement:
"All of the services included in AT&T's proposed competitor service basket are critical to an entrant's ability to compete with the ILECs in the local exchange market." (As read)
17582 That is just wrong, isn't it?
17583 MS MUIR: No, I wouldn't say it's wrong.
17584 MR. HENRY: Okay. Tell me why it's right.
17585 MS MUIR: Well, I think that --
17586 MR. HENRY: Tell me how switching and aggregation is critical to an entrant's ability to compete with the ILECs in the local exchange market?
17587 MS MUIR: Well, switching and aggregation is critical to an integrated carrier to compete in the market.
17588 MR. LAZZARATO: I think the more that AT&T Canada has been out competing -- and I am sure your own company's experience is the same -- is the more customers want integrated solutions. There are a very few customer examples I can think of where a customer has asked us for local service only, period, full stop, and perhaps has two or three other telecom suppliers providing each a laundry list of a half a dozen other services.
17589 What customers want is choice in numbers of competitors, but they also want to deal with a supplier who can do more than one thing for them. That simplifies their purchase experience, it simplifies it whether it is before installation or after installation. So being able to compete in the local area, it is critically important that we can also provide other services.
17590 MR. HENRY: If you get the discounts that you are asking for, it strikes me that they are going to benefit, primarily your data business, your Internet business and your long distance business, which form the bulk of your revenues? You break them down in your financial statements by those lines of business.
17591 MS MUIR: I think, though, it would just primarily benefit competitive entry in all those areas.
17592 Even if you think about it, that is how your affiliate competes. They get access from you for certain things to provide local or data, even though they are an IP broadband. I'm thinking of Nexxia here.
17593 So I just think it is to facilitate competition, which in turn facilitates local competition.
17594 MR. HENRY: Would the competitor services basket that qualifies for this discount also include construction charges and power delivery charges resulting from a subcontracted work relating to collocation?
17595 MS MUIR: Are you talking of power and space charges?
17596 MR. HENRY: Right.
17597 MS MUIR: Yes.
17598 MR. HENRY: The ones that are subcontracted and are flowed through to you on the basis of cost, you are aware that the Commission -- in Decision 97-15 I believe it is -- said those costs flow through to you, there is no markup. But you would get the 70 per cent discount on them. Is that right?
17599 MS MUIR: Yes. I really wish you wouldn't keep referring to is as a 70 per cent discount, but whatever is in the tariff, the tariffed rates are part of our basket. I'm not sure those are specifically identified as part of the tariff --
17600 MR. HENRY: What's your definition of --
17601 MS MUIR: Can I please finish?
17602 I'm pretty sure what you are referring to are not separate tariff items, so I am not entirely certain they would actually flow through.
17603 MR. HENRY: Is your definition of a discount something that only provides a price below cost? I think you said that in an interrogatory. Is that what you mean by "discount"?
17604 MS MUIR: Well, I think it's just we are a bit -- I think that's your definition --
17605 MR. HENRY: No.
17606 MS MUIR: -- and that is the connotation of discount. What we are asking for is a reduction in the price we pay so that it reflects really your cost of self-supply.
17607 That is the only reason I am objecting to the word "discount", it just has a pejorative meaning.
17608 MR. HENRY: So the 70 per cent rate adjustment figure that I think amounts to a discount would apply to construction charges that are flowed through to you at cost. Is that correct?
17609 MS MUIR: No. I don't think I confirmed that. I'm just saying I wasn't sure whether -- we are just talking about this specific tariff elements.
17610 MR. HENRY: So would that one --
17611 MS MUIR: I would have to actually look. It would have to be listed in the 3200. I think we just spoke about space and --
17612 MR. HENRY: But would you accept --
17613 MS MUIR: No. Well, you could say yes. We would have to look at the total bill for those tariff services and if that is included as part of the total bill, then it would flow through.
17614 I guess if that is an issue in terms of constructed charges specifically, I'm sure we could figure out a way not to include them.
17615 MR. HENRY: So you would be prepared to exclude those if they are not already included? It wasn't clear to me whether they were in or out.
17616 MR. LAZZARATO: MR. Henry, I think it's accurate that -- and we could go away and confirm this, but that space and power, the kinds of expenses you are talking about are not included in the $421 million subtotal on line 8, is it?
17617 MR. HENRY: And if they are, you would have excluded them?
17618 MR. LAZZARATO: Okay.
17619 MR. HENRY: By the way, just on that discount point, you said in 4202, on page 2, that:
"AT&T Canada's FBC rate adjustment factor was based on a comparison of AT&T Canada's own self-supply costs for competitive services in general." (As read)
17620 Then further down you say:
"Consequently, the rate adjustment factor is not a discount in the sense that the resulting rates would be below cost or in any way provide CLECs with a subsidy." (As read)
17621 So I'm saying that is your definition of discount: If it is below cost, it is a discount; if it is above cost, it is not a discount?
17622 MS MUIR: That's right.
17623 MR. HENRY: So the next time I go and buy a suit and I see one that says 25 per cent discount, I will have to ask them if it is below cost or not before I know if it is discount.
17624 MS MUIR: You know, if I were you I would just buy the suit. What do you care if it is below cost?
--- Laughter / Rires
17625 MR. HENRY: Well, I may or may not. We will see about that.
17626 Now, how about services that are currently priced at cost plus a 25 per cent markup, such as most of the essential and near-essential services? Would those be subjected to the discount?
17627 MS MUIR: They would be subject to the FBC rate, yes. The FBC rate applies to the aggregate purchase from the competitor.
17628 MR. HENRY: Right.
17629 MS MUIR: So purchase each item at tariff and subsequently the rate is applied.
17630 MR. HENRY: Okay. So let's make it simple. If I only bought services that had been priced at cost plus a 25 per cent markup, I would effectively -- the ILEC would effectively be providing them to you at 62.5 per cent below cost. Is that right?
17631 MS MUIR: That would presuppose of course that I accept your cost.
17632 But I think that is kind of an unrealistic way of putting it, because if you look at the services -- not just the services we purchase but even the other competitors, and you look at the distribution of our spend, a very small portion is spent on that particular service.
17633 So separate and apart from what you say the cost for that service is, we are looking at an aggregated basket of services and the cost to provide that basket of services which couldn't possibly be measured on a Phase 2 basis which looks service by service and measures the incremental cost of providing that service.
17634 MR. HENRY: What would your incremental cost be of something that had a price of a $125? Let me give you this example: Cost to us of a $100, price of $125, what would the incremental cost to you be of that?
17635 MS MUIR: I'm sorry, can you just repeat that?
17636 MR. HENRY: Price of $125, retail price of $125, cost -- well, not a retail price. This is an essential service priced at cost plus $25, the cost is $100, the price is $125, what would your incremental cost of the one next loop you buy from us -- not one next loop, one next service of this nature from us? What would the incremental cost be?
17637 MS MUIR: Well, I guess what I am saying is that when you supply yourselves with services so that you can provision your end customer, you do it through a whole series of stuff. So that we are not looking at the incremental cost on a service-by-service basis.
17638 If you are just assuming that here is the one next loop and I don't have a fixed network underneath, and you are telling me that one next loop cost $100, that is the cost. But we are saying to you --
17639 MR. HENRY: What is the cost?
17640 MS MUIR: A hundred dollars I guess, if you tell me --
17641 MR. HENRY: Your incremental cost is $100?
17642 MS MUIR: I'm sorry, I must have not understood your question then.
17643 MR. HENRY: I will try again.
17644 The price is $125, our cost is $100. I thought your proposal was that you would get it for $125 minus 70 per cent or $37.50. Is that not right? What would you record in your books?
17645 MS MUIR: I already told you, I just wouldn't be buying that one loop though.
17646 MR. HENRY: I am talking about an incremental cost, we will look at the one next loop you are buying from us. Just focus with me. One next loop, okay? You have done many of these incremental studies before.
17647 I know, Mr. McLennan, you don't like the incremental cost studies, but --
17648 MS MUIR: But all I'm saying to you is --
17649 MR. McLENNAN: I have been very impressed with them, sir.
17650 MR. HENRY: As I recall, you didn't think they were enough to recover -- to make business decisions on. But anyway, we won't go there.
17651 I can't believe it, this is a very simple question. What would you pay for that one extra loop if that was the price -- or service?
17652 MS MUIR: But we are not talking about pricing out incrementally on a service-by-service basis. So if you are talking about our proposal, we are not talking about the incremental purchase of one loop. We are talking about purchasing a basket of services and the cost of that basket of services to you.
17653 MR. HENRY: Mr. Lazzarato, how would you record it in your books? Would you record $37.50 cost or $125 cost?
17654 MR. LAZZARATO: If you ask me -- if I can restate the question to make sure I understand it.
17655 MR. HENRY: It's not complicated.
17656 MR. LAZZARATO: Well, it might be more complicated than you are trying to lead us to believe.
17657 If the total basket of services we purchased from ILECs or Bell Canada individually, if the total basket of services we purchased was $125, then yes, we are suggesting that we would pay $37.50 for that basket of services.
17658 MR. HENRY: Thank you.
17659 It took a long time to get that.
17660 MR. LAZZARATO: But not for incremental services, as Ms Muir was saying. We are talking about a basket approach.
17661 MR. HENRY: I know you are.
17662 Now, I want to understand how this 70 per cent discount would work in practice. I think we established that if you took $100 of service, a whole mixed bag of services, you would pay $30. So for that $30 to be at or above costs, the ILEC's costs would have to be $30 or less. Correct.
17663 MR. LAZZARATO: That's right.
17664 MR. HENRY: So if we assume the ILEC's cost were $30 or less and its price was $100, Mr. Koch's engineer friend who advised him the other day on how to do this math advised me that this implies a markup of at least 233 per cent. Would you agree with that, 100 minus 30, divided by 30. Is that correct?
17665 MR. LAZZARATO: The math sounds good to me.
17666 MR. HENRY: Okay. So if you assert that the application of your discount would leave the ILEC rates for competitor services above cost, it follows that the ILECs must currently have markups of at least 233 per cent on average for the services in your proposed competitor services basket, doesn't it?
17667 MR. LAZZARATO: I can't speak to all services from ILECs in the competitor services basket --
17668 MR. HENRY: Well, you just did earlier.
17669 MR. LAZZARATO: -- but I can suggest to you that what we are looking at when we say "cost", we are trying to determine what we believe your incremental cost of self-supply is.
17670 MR. HENRY: Right. Okay.
17671 MR. LAZZARATO: We also look at the utility rates of return. The only public information we have are prices we are charged and overall returns different incumbents earn. That is where a significant disconnect occurs, at least to me as a financial person, trying to understand how you can be limited to a 25 per cent markup, you believe, and yet incumbents are earning somewhere between 15 and 27 per cent on their utility businesses. That is what we find difficult to understand.
17672 MR. HENRY: Well, we don't separate out, to my knowledge, the markups on competitor service basket, as you call it, separately, so I don't see what those --
17673 MR. LAZZARATO: I was using the number you just said of 25 per cent. The rates of return I was talking about have been filed elsewhere in evidence in this proceeding.
17674 MR. HENRY: The rates of return cover the whole utility segment, not just the services provided to a competitor.
17675 MR. LAZZARATO: I understand.
17676 MR. HENRY: This is why at the very beginning I asked you: Are you saying that this would cover the cost of providing the services to you. The prices from you cover the cost of the services we provide to you, or what you just said implies that all the services we get, the prices for competitor services and retail services, generate returns that you think must cover our costs in total. Now, which is it?
17677 I thought I got an answer earlier that said it was the competitor services that you want from us that you say with this 70 per cent discount will be priced above cost. If that is true, that implies a minimum 233 per cent objective.
17678 MR. LAZZARATO: Mr. Henry, I apologize for having to ask you to repeat that question, but it is the longest question we have had today. So if you could just repeat the question, I would be happy to answer it.
17679 MR. HENRY: It was probably the longest question you have had today because I have been the only one asking them.
17680 Didn't we establish that for it to be true that we are covering our costs, under your proposal, of supplying competitor services to you that the services we provide to you, which have nothing to do with the utility rate of return which covers all the services we provide to others, would have to have a markup of 233 per cent?
17681 MR. LAZZARATO: If you use our definition of costs, which is incremental cost of ,self-supply as opposed to definitions of costs you currently use, yes. There are substantial differences in those two definitions, as you know.
17682 MR. HENRY: Well, let's take loops as an example. I will use Bell Canada rates because I am familiar with them.
17683 Loops in Band A, according to the Commission's recently determined costs, are $9.04 and loops in Band B are $12.82. Now, I take it you would agree with me that these rates do not have a 233 per cent markup? That would imply a $3.97 cost in Band A and a $5.50 cost in Band B. Right?
17684 MR. LAZZARATO: I don't know what your costs are. That is not available to me.
17685 MR. HENRY: Well, the Commission certainly knows them.
17686 Are you telling me you think there could be a 233 per cent markup in Band A loops, so that the cost is $3.87 in Band A. Is that your evidence?
17687 MS MUIR: Actually though, it goes back to the fact that we are looking at an aggregate purchase of service. So if you are looking at loops in Band A, perhaps there is not a 233 per cent markup.
17688 MR. HENRY: And there is a lot less, isn't there?
17689 MS MUIR: I have no idea actually.
17690 But even loops in Band A I think you are not happy with what the Commission says your costs are. But you can't look at it that way if you are looking at our proposal. It is an aggregate basket of services. And potentially there is a 233 per cent markup on that aggregate basket of services.
17691 MR. HENRY: If the loops in Band A are priced at $9.04 and they have a 25 per cent markup, surely that is considerably -- that price, that cost is considerably above the $3.97.
17692 So I think we can agree that the loops would not have a markup anywhere near 233 per cent.
17693 MS MUIR: I think I just explained to you, though --
17694 MR. HENRY: Right.
17695 MS MUIR: -- you are looking at an aggregate purchase.
17696 MR. HENRY: Okay. So that aggregate means, then, that there are a lot of other services that must have markups of much greater than 233 per cent. Correct?
17697 MS MUIR: It probably does. But what we are actually talking about here is your cost to supply yourself with the facilities that we use.
17698 So it is not clear to me that even if you measure loops in Band A on a Phase 2 basis and look then at another service on a Phase 2 basis, that we would ever be able to actually know in aggregate what your costs are for that group of services because there is no kind of check as to what you actually say are part of the cost of the loop perspectively and incrementally relative to what you say part of your digital access is incrementally, and so on.
17699 So we never have any kind of aggregate check on what your costs are. We just have little isolated pieces that you construct and then we look at that for that purpose of that little item and we are talking about an aggregate.
17700 MR. HENRY: Well, let's look at some of these little aggregated items. If you would turn to The Companies(CRTC)800, please.
17701 MR. HENRY: Now, in the attachments to that interrogatory, there are 14 pages of essential or near essential services. It shows the pricing and whether or not they have been priced with a markup of cost plus 25 per cent. Would you agree with me that most of these services have been priced based on cost plus 25 per cent, although, I understand certainly not all of them?
17702 MS MUIR: I would agree with you that they are based on your Phase 2 cost, and where there is an "X" you say they are at cost plus 25 per cent.
17703 MR. HENRY: The markup, then, on these services is much likely less than 233 per cent?
17704 MS MUIR: I couldn't actually agree with that. But I'm not -- I think you are still not understanding I'm not looking at it on a service-specific basis, I'm looking at it as a basket of services.
17705 MR. HENRY: I take your point. I'm going to come back to that, but I just want to get a sense, when we are through this basket, where we are left. So I kind of want to go through each one and then see if your assertion makes sense.
17706 MS MUIR: We can't go through each one and see if my assertion makes sense. That's all I'm trying to explain to you, is that if you are looking at something in aggregate, I'm particularly looking at it at what your underlying facilities cost you to serve the customer versus what you charge us for those same facilities so we can compete with you to serve the customer.
17707 So we are actually not talking about looking at it on a service-by-service basis. Because in order for me to go through this and accept that, I would have to accept that that is your cost of self-supply that we are talking about, as opposed to a Phase 2 study.
17708 MR. HENRY: So if I understand you correctly, you are saying you agree that, in aggregate, the services all have to have at least a markup of 233 per cent, but you just don't know what portion have a markup that would be quite less, based on cost plus 25?
17709 MS MUIR: I wouldn't actually have that information but, yes, I would say if that's what you are telling me that you would need, then you have a markup of 200 per cent.
17710 MR. HENRY: I'm not telling you. You told me, I think -- or Mr. Lazzarato did -- the math works. A hundred-dollar costs, with a 70 per cent rate adjustment factor, implies a 233 per cent markup. Right?
17711 MR. LAZZARATO: Mr. Henry, I don't think the substance of the question here is whether two numbers divided together are the right ratio. The question that Ms Muir is trying to help you understand our position in is what we are trying to do is determine your incremental costs of self-supply. We are not saying that that necessarily equates to a different cost methodology that have been used.
17712 MR. HENRY: Would Centrex be an example of a service purchased by AT&T that is significant, in terms of volume?
17713 MS MUIR: I guess we spent $85 million on Centrex.
17714 MR. HENRY: You are aware that Centrex rates vary depending on the customer's volume?
17715 MS MUIR: The retail rates? Yes, I'm aware of that.
17716 MR. HENRY: They vary from, say, $38 a month for a small customer to $22 for a large contracted customer?
17717 MS MUIR: That's right. Actually, if you take the government, they are actually lower than $22.
17718 MR. HENRY: Yes, $21 for a national customer committing to a five-year contract. I think that's the lowest rate, isn't it?
17719 MS MUIR: I think for Bell, it's probably $22.05.
17720 MR. HENRY: My information is $22.05 for the large contracted customer and a national customer, with 50,000 locals at five years, could get as low as $21. Fair enough?
17721 MS MUIR: That's fair enough.
17722 MR. HENRY: In one of the interrogatories, I think, you indicated that 45 per cent of your NAS are Centrex resale.
17723 MS MUIR: Yes, 45 per cent of our NAS are resale, yes.
17724 MR. HENRY: Right. So can we safely assume that AT&T is more typical of the large contracted Centrex customer?
17725 MS MUIR: Are you asking me what basis we purchase on?
17726 MR. HENRY: Right. It's the 22.
17727 MS MUIR: Yes, we are a national customer.
17728 MR. HENRY: Right. Is it plausible to you that the $21 rate reflects a markup of greater than 233 per cent?
17729 MS MUIR: What is plausible to me is perhaps the station connections that would be used by the ILEC would reflect a markup. So what we are talking about is how the ILEC supplies that service to themselves.
17730 So when you take the station connection so that you can provide Centrex service, it is plausible that there is that markup. Have I actually studied that? No, I haven't.
17731 MR. HENRY: Are you suggesting that the cost of the $21 rate to the ILEC is less than $6.30?
17732 MS MUIR: It's possible. What I'm saying though still goes back --
17733 MR. HENRY: It's possible?
17734 MS MUIR: It's possible.
17735 MR. McLENNAN: I will tell you what I think. I don't think you can determine what your cost is until you take your total cost that appears on your income statement and allocate it across all of your services and then do a reconciliation of your total cost by each service, and then you will have some idea of what your cost is for that Centrex line.
17736 If you pick out services one by one and allocate whatever to it and don't do a reconciliation back to your balance sheet or your income statement, you have no idea what your costs are.
17737 MR. HENRY: I thought we established that Bell's loop cost alone in band B is $10.25 -- $12.82 less the mark-up.
17738 MS MUIR: Actually, we didn't establish that.
17739 MR. HENRY: Okay. It was $12.82 in band B, do you accept that -- the price?
17740 MS MUIR: The price.
17741 MR. HENRY: The cost, then, based on the Commission's methodology, is $10.25.
17742 MS MUIR: But the thing -- I think what we are saying here is that's not an appropriate way to cost out the services that we buy from you. What we are saying is you have to take an aggregate look.
17743 MR. HENRY: So it's your evidence that those costs could be as low or even lower than $6.30 for Centrex. Is that it? I'm quite willing to accept that that's your evidence.
17744 MS MUIR: No, that's not our evidence. Our evidence is when -- we don't know what your cost is, but when we look in aggregate, we don't think that using a Phase 2 cost is an appropriate way to calculate what it costs the ILEC to supply these services. Because what we are trying to get at is a certain kind of competitive parity so that we are provided with the same advantage the ILEC has in supplying services to the end customer.
17745 MR. HENRY: So what would you use, a Phase 3 cost?
17746 MR. McLENNAN: I would use cost structures that businesses use to manage their businesses, where you take all of your aggregated costs, you allocate all of your costs against all of your services, which is what happens in businesses, and then you determine where the costs are allocated. There is tremendous subjectivity when you are sharing infrastructure and network across multiple services.
But you cannot determine cost per service until you take your total costs and roll it up by service and then audit it and understand it. So a lot of work involved to truly understand what your costs really are by service.
17747 MR. HENRY: So you are talking about fully allocating costing, something which this Commission rejected years ago, but that's what you are talking about?
17748 MR. McLENNAN: I'm talking about how you manage a business and how you manage and operate a company to be successful in the financial markets. What they do is they understand your total cost and you understand your cost per service, and then you go from there. That's how you really truly understand it.
17749 But when I take a look at your total overall results in the last three years during this last price cap regime, I can tell you something. When I look at your overall results, your costs have either reduced incredibly rapidly across your total service offerings, or in fact you have grown revenues dramatically with no costs attached to them at all, which is an extraordinary event. Because, in fact, what happens with the results, as I see them, is that your net income and your profits have increased to twice the rate of your revenue.
17750 So when I came back and take a look at the overall cost structure of your company, the financial results, and then I take a look at the work that we did to try and figure out what it would cost if we could put it on our own network, it's very difficult for us to determine what your costs are, so we did the best we could.
17751 MR. HENRY: The best you could, using no capital, using a network that serves high density areas and using a very little bit of expense. I understand that --
17752 MR. McLENNAN: This is actually --
17753 MR. HENRY: That's an interesting way to do it.
17754 MR. McLENNAN: This is actually, Mr. Chairman, where I may be able to share what the problem is. But maybe I will do it another time if it's appropriate. But if we want to talk about what your total costs are, now is the time for me to explain the problem. If you want me to do it at another time, I will do it at another time.
17755 MR. HENRY: Go ahead, Mr. McLennan.
17756 MR. McLENNAN: All right, I will be delighted to do it. Thank you very much, Mr. Henry.
17757 The point I would like to make is that scale is an incredibly important advantage in a cost structure, especially when we are talking about a network that has pre-existed for many number of years, very high fixed-cost infrastructure, ubiquitous network reaching out to essentially 100 per cent of all customers, something that we don't have and there was a cost that was fixed in structure over many, many years to put that in place.
17758 That cost structure, that total cost structure, if I was a business manager responsible for the profit and loss of that business, I would look at my income statement, my cost of sales and what is really driving my business. I see extraordinary returns growing very dramatically, up to 16 per cent, in some cases, 20 some per cent in others.
17759 And I understood, from listening to the presentations earlier in this proceeding, that those results will only go dramatically higher if your proposal, in fact, is accepted. I mean, I heard rates of going up north of 20 per cent. That advantage in the market place against new entrants is insurmountable if it's not addressed.
17760 So this is how it works. The harder we try by securing new customers and we acquire facilities from you and we pay the rates that we are paying now, we fall further behind every time we buy facilities from you and go out and try and secure a customer. And we do that because we are paying you full rate of some cost -- based on some cost that we don't understand and, in fact, it creates an even greater contribution to your bottom line. There is a fundamental inequity between cost structures. There is no competitive neutrality and without that you cannot have a maintainable competitive environment, whether it's in any industry.
17761 The reason I would put to you that wireless was so successful starting 16 years ago, because cost structures started basically the same. There was no head start, cost structures were equal and the war really took place in front of the customer and it really took place in who could be innovative and aggressive and whatever because you had basically a competitive neutral cost structure.
17762 I'm saying to you that the scale advantage on all of the issues that I talked about in your inherent network represents a dramatic competitive edge over new entrants. What we are trying to address, without coming up with very, very radical suggestions, is how to go forward from here on a competitively neutral basis.
17763 That's why we tried to figure out what it would cost if we could put everything on our own networks, and also taking a look at your total financial returns, we believe your cost structure is open for discussion, as to what your real cost structure is. I mean the kind of cost structure that you go back and look at every month to measure your profitability, your operational returns and what is really driving your business.
17764 MR. HENRY: In these returns you talk about, you said one north of 20 --
17765 MR. McLENNAN: Yes.
17766 MR. HENRY: -- of course, you haven't taken into account?
17767 MR. McLENNAN: I heard that earlier in these proceedings that if your price increases that you have recommended are in fact enacted, could take you 16 per cent, 17 per cent, 20 per cent plus.
17768 MR. HENRY: Have you heard the evidence from TELUS, for example, on the amount of money that is already reflected in Commission decisions, such as contribution for next year and so on and where those returns would go? And have you factored in --
17769 MR. McLENNAN: I think I have heard the percentages for TELUS. They are in the neighbourhood of 27 per cent today --
17770 MR. HENRY: Yes. And do you know where they go tomorrow, based on the Commission's decisions already made? No?
17771 MR. McLENNAN: I don't know all the numbers, Mr. Henry.
17772 MR. HENRY: Well, a couple of numbers were thrown around this morning.
17773 MR. McLENNAN: What do they fall down to? I mean --
17774 MR. HENRY: They were in the orders of magnitude below that. Have we looked at your numbers with the $320 million that Mr. Grieve mentioned the other day that you get just with the things you have already gotten from the Commission --
17775 MR. McLENNAN: I will tell you what, I look at my numbers every week, every month, every quarter.
17776 MR. HENRY: Are they improving?
17777 MR. McLENNAN: No, they are not. Well, some operational numbers --
17778 MR. HENRY: EBITDA? EBITDA?
17779 MR. McLENNAN: Some operational numbers are improving.
17780 MR. HENRY: Right.
17781 MR. McLENNAN: And I feel very good about that because some of the contribution assignments that were made were very, very helpful to us, have not resulted in any kind of dramatic repricing in the market place and that has been helpful.
17782 It was a good small start.
17783 MR. HENRY: Right.
17784 Now, let me ask you, does AT&T consider that if the ILEC prices for services provided to competitors were done under the AT&T proposal, that AT&T -- and you say that's still above cost, and I take it you think that you would be better off with the proposals that said provide them at cost, you are being more generous. If I hear you correctly, you are being more generous to the ILECs than asking for services to be provided at cost.
17785 MS MUIR: I'm not sure --
17786 MR. HENRY: You said you are still going to leave us above cost.
17787 MS MUIR: -- I understand your question. I'm sorry?
17788 MR. HENRY: You said you are still going to leave us above cost, right? You said --
17789 MS MUIR: What was said is you would be -- you would be able to recover your costs with self-supply, yes.
17790 MR. HENRY: Right. Is that better than pricing at cost? Is that better for you than pricing at cost?
17791 MS MUIR: Well, what we -- what we did -- I'm not sure I understand your question. We would suggest to you that your costs of self-supply is probably lower than the number we calculated for ourselves, for a variety of reasons.
17792 I'm not sure what you mean by "at cost". All we are looking for is to try to get a proxy for what it costs the ILEC to provide the same services that we provide to the end customer so that there would be some kind of parity, so that there would be competitive neutrality, in terms of the way we deliver service.
17793 MR. HENRY: Now, what happens if we implement your proposal and the ILEC's retail prices go down? Do you get the discount off the new lower retail price?
17794 MS MUIR: Yes -- well, what you are suggesting is that a service --
17795 MR. HENRY: Centrex price drops tomorrow to $17, do you still get the discount?
17796 MS MUIR: Yes, we would tag it off the tariffed rate, that's correct.
17797 MR. HENRY: Right. I don't understand that because your 70 per cent discount was constructed based on supposedly our cost structure. Now, our cost structure hasn't changed, but our prices went down. Do you still get the 70 per cent discount?
17798 MS MUIR: No, actually the 70 per cent is based on our -- our -- cost structure, if you get right down to it, as proxy for your cost structure. So I don't think because you reduced your retail price your cost structure changes at all.
17799 MR. HENRY: But that's how you determined -- well, exactly, that's my point. Our cost structure hasn't --
17800 MS MUIR: But we are talking about your --
17801 MR. HENRY: Our cost structure hasn't changed --
17802 MS MUIR: -- cost of self-supply here.
17803 MR. HENRY: Well, you say the prices you give us would be above cost.
17804 MS MUIR: Right.
17805 MR. HENRY: Okay? And our cost structure is below that price.
17806 MS MUIR: Right.
17807 MR. HENRY: Now, you drop those, or the retail rates drop and you get 70 per cent. Wouldn't that put you potentially below cost?
17808 MS MUIR: I would have to look at it all in aggregate, so how much Centrex makes up of our aggregate purchase and where you are in aggregate above your cost.
17809 MR. HENRY: But it could put it below cost, and you would still want the -- you would still get the 70 per cent discount. The Commission shouldn't worry about that?
17810 MS MUIR: Well, I guess you would have to be able to demonstrate through some sort of pricing -- or costing of your aggregate basket of services and look at it in aggregate because we are talking your self-supply here. So your cost structure doesn't change as your price fluctuates, so what you are suggesting is: how do I know whether you are below cost or not?
17811 MR. HENRY: And I think you -- I don't think you care, by the sounds of your proposal. If you do care, then it sounds like we are going to have an awful complicated process to decide every time a price changes, does this aggregate number still take us below cost here?
17812 MS MUIR: It probably is less complicated than you think, if you just constructed some sort of cost structure.
17813 MR. HENRY: Oh, based on your cost? Sure, I guess that's pretty simply to do. We could take those numbers. Is that how you propose we do it, just take what you pay us and that would be our cost structure?
17814 MS MUIR: No. I would suggest your cost structure, in terms of supplying services to your end customer, probably looks better than what we are proposing --
17815 MR. HENRY: So how do you want us to do our cost structure? Phase 2? Phase 3? Some three-line thing like this, using AT&T's revenues that they pay the ILECs? Which way do you want us to do it?
17816 MS MUIR: Well, I think we said, if, in aggregate, you could demonstrate that you were below cost in aggregate, we would accept that. We wouldn't certainly expect on your aggregate services that you would be not recovering your cost.
17817 THE CHAIRPERSON: Mr. Henry, since we started earlier this afternoon, I would like to take our --
17818 MR. HENRY: It's a good time to break, yes.
17819 THE CHAIRPERSON: Okay.
17820 MR. HENRY: That's fine.
17821 THE CHAIRPERSON: We will take our afternoon break now for 15 minutes.
--- Upon recessing at 1514 / Suspension à 1514
--- Upon resuming at 1532 / Reprise à 1532
17822 THE CHAIRPERSON: Order, please, ladies and gentlemen.
17823 We will return to our proceeding now and turn the questioning back to Mr. Henry.
17824 MR. HENRY: Thank you, Mr. Chairman.
17825 Now, I want to explore just a little bit further how this 70 per cent discount might apply or play out in the marketplace.
17826 First of all, am I correct that it only applies to CLECs? I think in your evidence you say Canadian carriers, but then I think you revised that in your interrogs to say CLECs. Is it CLECs or --
17827 MS MUIR: It's CLECs.
17828 MR. HENRY: It's CLECs, okay.
17829 MS MUIR: The main reason we revised it is there is an obligation to invest in facilities.
17830 MR. HENRY: Yes. Okay.
17831 And would it apply to Bell Intrigna?
17832 MS MUIR: Yes, it would apply to Bell Intrigna. I think that's also in our interrogatory response.
17833 MR. HENRY: Yes, and TELUS operating in Ontario and Quebec, for example?
17834 MS MUIR: Right.
17835 MR. HENRY: Okay.
17836 So a Canadian carrier that wants to operate as an inter-exchange carrier or a switch-based long distance service provider would not get the discount. Correct?
17837 MS MUIR: Not the way we have it, no.
17838 MR. HENRY: All right.
17839 MS MUIR: We said it only applies to CLECs.
17840 MR. HENRY: And so Primus, for example, would not get it?
17841 MS MUIR: Unless Primus is a CLEC, no, Primus would not get it.
17842 MR. HENRY: Right. And all the ISPs who buy ISP link and the various other services from the ILECs, they would pay full freight, as well, while AT&T's ISP business would get the 70 per cent discount?
17843 MS MUIR: I think what we are saying is anybody who is a CLEC, simply because the CLEC has a certain number of obligations to meet, is eligible for the FBC rate.
17844 MR. HENRY: So because of that, you don't think that would give you an advantage over suppliers like Primus or the ISPs? You would compete with ISPs who didn't get this discount?
17845 MS MUIR: I guess we would look at it the same way that you compete with us and you have a certain cost structure. Since we are trying to foster local competition, we decided to have that apply to CLECs.
17846 Now, if the ILEC was to broaden it, that, of course, would be the ILEC's prerogative. But really, we were looking at promoting a facilities-based type entry.
17847 Actually, we gathered from some of your questions there was a concern that it might be too broadly available -- perhaps it was TELUS' questions -- where a large retail customer could actually apply for these. We just wanted to assure you that it's really there to promote facilities-based competition.
17848 MR. HENRY: And what about wireless CLECs, such as Microcell. Would Microcell be able to terminate long distance calls on ILEC facilities at a 70 per cent cost advantage to the wireless carriers that are not CLECs?
17849 MS MUIR: I think that I have made it pretty clear that it's available to CLECs. To the extent that somebody is -- in our proposal anyway -- to the extent that somebody is a CLEC, whether they are a wireless CLEC or not, they have met certain obligations, they are entitled to certain things. The same as a CLEC today is entitled to get loops.
17850 MR. HENRY: And what about -- well, a CLEC is entitled to get loops, but so are DSL service providers, as well, aren't they?
17851 MS MUIR: Yes, they are.
17852 MR. HENRY: And they are not CLECs.
17853 MS MUIR: Yes, you are right. You are absolutely right.
17854 MR. HENRY: But it wouldn't be available to DSL service providers. They would have to pay full freight for the loops?
17855 MR. McLENNAN: Is there a DSL service provider left, Mr. Henry?
17856 MR. HENRY: Well, I know we certainly have a wholesale market for loops to DSL providers.
But anyway --
17857 MR. McLENNAN: I know there was --
17858 MR. HENRY: In any event, whether there isn't or is, they couldn't get it. If there are, and they couldn't get it if one appears. Okay.
17859 While we are talking about Microcell just for a minute, my understanding -- and I may be wrong -- is that Microcell operates as a CLEC in some regions of Canada and not in others. How would that work? They would get the discount on some of our revenues, but not others?
17860 MS MUIR: I guess if they operate in some regions of Canada, they purchase from the ILEC in that region of Canada. I think that's how it would work. I think that's probably how it works everywhere. That we, when we are operating in TELUS' territory, actually, purchase from TELUS' carrier services group. So I think it would work entirely the same way that it works today.
17861 MR. HENRY: Okay. What about other facilities-based wholesale providers like Group Telecom? Would they be required to give you a 70 per cent discount?
17862 MS MUIR: Actually, no. We actually answered that question. Because we are trying to replicate the ILEC's cost of self-supply so that there is a level playing field between the ILEC and entrants, it's not necessarily the case that the cost of self-supply to Group is the same as you.
17863 MR. HENRY: But if the ILEC was giving you a 70 per cent discount, do you assume that the non-ILEC -- and let's take Group Telecom as an example -- would not match that discount? Do you assume that they would still continue to sell at retail?
17864 MS MUIR: I'm not sure I understand your question.
17865 MR. HENRY: Well, if the ILEC was giving you a 70 per cent discount and Group Telecom is out there selling wholesale market, as we have heard many times this week, you don't think there would be pressure on them to drop their rates by 70 per cent, as well?
17866 MS MUIR: I would assume that if there were a huge wholesale market out there, we would have a lot more choice than just purchasing from you.
So what Group Telecom, or even for that matter AT&T Canada decided to do with their rate, would really be a reflection on what Group Telecom or AT&T Canada could afford to do with their rate.
17867 MR. HENRY: Well, let me ask it this way, Mr. Dixon -- I don't know if you heard him earlier this week -- mentioned that he purchased significant service from GT out west -- Bell Intrigna does. Now, why would he continue to do that if he could go to TELUS and get a 70 per cent discount, unless GT was prepared to match the discount? Do you think he would?
17868 MS MUIR: I would think that Mr. Dixon would make the proper economic decision, given his circumstances.
17869 If you are suggesting that somehow there wouldn't be a wholesale market out there, really, I think it's our contention there is not really a big wholesale market, contrary to what Mr. Dixon said. Where we could purchase facilities from somebody else because we get a better price, by and large, we try to do that. But nobody has a ubiquitous network, except for the incumbent.
17870 So it's only where somebody else has facilities that an entrant is able to do that anyway. So it's not as if the entire wholesale market, the bottom will fall out of it. Because if you will recall Mr. Dixon, when we were talking about service level agreements or giving discounts to entrants like AT&T Canada, he also hadn't entered into any with any of us. I think probably the main reason he hadn't done that is we don't have a lot of choice for everything we buy. We really have to go to the ILEC for the majority of the services we purchase.
17871 MR. HENRY: I don't know whether you do as a matter of choice, but have you not heard evidence that people are going to Group Telecom, Videotron, AT&T, CallNet for wholesale facilities?
17872 MS MUIR: Yes, as a matter of fact, I know who we go to, but the bulk of the services that we purchase are by force from the ILEC because nobody else has facilities that cover all the areas. For certain --
17873 MR. HENRY: And these -- sorry. I'm sorry. Go ahead.
17874 MS MUIR: For certain services, we may be able to get a better price from somebody else in the market but, generally speaking, we have no choice That's why, generally speaking, even if we were to go to your affiliated companies, we don't get better price treatment from them because why would you lower your price to somebody who has no other option?
17875 MR. HENRY: If some of these companies had a strategy of building facilities and aiming at the wholesale market, do you think they could continue that when everybody else now can come to the ILEC and get a 70 per cent discount?
17876 MS MUIR: No. Right today, if you look at how the competitive market is unfolding just over the course of the last year, many, many competitors have actually gone into receivership, I think probably eight or nine over the last eight or nine months.
17877 MR. HENRY: Right. And by the way, where did the customers go?
17878 MS MUIR: I guess they were split up among the remaining carriers. But that's not really my point.
17879 My point is where will this wholesale market come from? Like, there are very few competitors left in the market place. Even Group Telecom, who you are pointing to, is not in solid financial position right today. So if you are suggesting that there is going to be a huge wholesale market out there for facilities that we already can get from a ubiquitous carrier, I think that's just a wrong notion of what's happening out in the market place.
17880 MR. HENRY: So it is your evidence then that your proposal is not really designed to provide facilities-based competition? Didn't you just say that?
17881 MS MUIR: Yes, our proposal is to design facilities-based competition. What we are suggesting is that, in order for competition to emerge, there has to be a level playing field. And because the incumbent has a significant advantage, by virtue of its network, entrants have to have access to that network at the same cost that it costs the incumbent to supply services to their end customer.
17882 MR. HENRY: Mr. Towner, of TELUS, was here just the other day, and I don't know if you heard him. He indicated that TELUS bought more facilities from GT out of territory than GT bought from TELUS.
17883 Now, if TELUS could get a 70 per cent discount from Bell in Bell's territory, why would it continue to buy from Group Telecom, unless Group Telecom reduced its rates? Why would it do that?
17884 MS MUIR: I think I answered your question. I think I suggested to you that there is probably not really a huge wholesale market and that --
17885 MR. HENRY: What has that got to do with it?
17886 MS MUIR: Well, if there is no competition, there is no Group Telecom over the longer term. So there is nobody else who has facilities but the incumbent. Now, if Group Telecom felt they could afford to reduce their rates for whatever services they are now providing TELUS by 70 per cent, I am sure they would -- if you are suggesting the floor price would be the incumbent's price -- I think that's how it works today.
17887 MR. HENRY: Right. So they would be -- I think what you just said is that they would be forced to drop their rates significantly.
17888 MS MUIR: No. I didn't say they would be forced to drop their rates significantly. What I said was they would have to look at what they have, but what I am really saying is, unless there is a dramatic change, I don't honestly believe there will be a Group Telecom or a lot of competitors in the marketplace period.
17889 MR. HENRY: So anybody who has pursued that facilities based strategy is going to have to abandon -- at least at the wholesale market?
17890 MR. LAZZARATO: Mr. Henry, I think that is what Ms Muir is saying we have really seen in the last couple of years.
17891 MR. HENRY: Okay.
17892 MR. LAZZARATO: Is that the size of the wholesale market has almost evaporated, diminished significantly, at a minimum. If there is not a change in the methodology here in order that sustainable competition can survive, without naming individual competitors or surviving entities, then it is a rhetorical question to ask whether a wholesale provider would reduce his price if the wholesale provider didn't exist.
17893 MR. HENRY: So, I believe you said in your evidence that the local competition market was on the verge of collapse. Do you recall that? Is that what you are saying now?
17894 MR. LAZZARATO: Can you point out in the evidence -- I don't recall the exact phrase.
17895 MR. McLENNAN: If what you are saying, Mr. Henry, is that there will not be a facilities based competitive marketplace unless there are significant changes, I would agree with that.
17896 MR. HENRY: Well, it was page 26, paragraph 4-1, you said in your written evidence, filed in August, that competition in the local market is on the verge of collapse. Do you see that? Up near the top? Paragraph 4-1?
17897 MR. McLENNAN: I think that is what I just said.
17898 MR. HENRY: Yes. Now, I would kind of like to contrast that with what you may have been telling investors just a few months earlier and I wonder if you could pull out the prospectus that I handed you earlier.
17899 This is a prospectus which I understand was used for when you raised $500 million U.S. dollars, like I said, it is over $700 million Canadian in debt just earlier this year.
17900 Can you tell me, Mr. Lazzarato, when you this kind of a deal, a huge deal like this, it is important to disclose truthfully to your investors all material facts and risks that the company faces, correct?
17901 MR. LAZZARATO: Absolutely, Mr. Henry.
17902 MR. HENRY: I though it was interesting to see how you had characterized local competition to your investors just a few months earlier. Could you turn, please, to page 14 of the prospectus?
17903 Are you there at the top
17904 MR. LAZZARATO: Yes.
17905 MR. HENRY: Let me just read it.
17906 "The company..."
17907 This is AT&T Canada "...also faces competition from entities utilizing other communications technologies and may face competition from other technologies being deployed or to be developed in the future, for example, there is a trend toward the convergence of the telecommunications and cable industries. The CRTC has indicated its willingness to permit telephone companies to operate cable businesses and the company anticipates that cable businesses will continue to expand into providing telecommunications services particularly local access and high speed residential internet services. The convergence of the telecom and cable industries may add substantial new competition which could adversely affect the operations and financial conditions of the company. There can be no assurance that one or more of the technologies currently utilized by the company will not become obsolete at sometime in the future.
The company believes that providers of wireless service will increasingly offer products that will compete with and ultimately may replace certain wire line telecom services, using new wireless technologies. Competition with providers of wireless telecom services may be intense and may further limit the prices at which the company can profitably compete." (As read)
17908 Now, that is quite a different story than you told the Commission, isn't it?
17909 MR. LAZZARATO: Absolutely not.
17910 MR. HENRY: Well, that doesn't sound like a market on the verge of collapse, does it?
17911 MR. LAZZARATO: What we have said in this document, let me preface by saying you are referencing a securities document and, as any public company, when we raise money, debt or equity, in a public market, we are held to a disclosure standard to accurately describe the current state of affairs and under certain sections here describe what are termed, for security purposes, the risk factors associated with our business.
17912 MR. HENRY: Right.
17913 MR. LAZZARATO: You will notice the use of the word "may" in that paragraph or those two paragraphs that you have just read.
17914 I think the evidence from the first panel that this hearing heard talked about the non-existence today of any competition from cable companies.
17915 What we are saying here is that other technologies may result in competition. That's right. And it could be intense, and we are covering what security lawyers would call our legal derrieres in terms of disclosing all possible risks to the business and to the debtholders potentially being repaid.
17916 But I believe, as the evidence we heard at the beginning of the second preceding week, non of that competition exists today and I believe those words accurately say that.
17917 When we say local competition is on the verge, as you are referencing our other document you referenced at the beginning of this sequence, we are talking about the sustainability of competition, not the fact that there are a number of people out there trying to compete, but the likelihood that those people are going to survive. That's what we meant by on the verge.
17918 MR. HENRY: And you are talking here about potentially intense competition from cable and potentially intense competition from wireless.
17919 I take your point that you don't put the pin in as to when, but the fact that you are saying this, you see it on the horizon.
17920 MR. LAZZARATO: We see that its potential, yes, absolutely.
17921 MR. HENRY: How many cable companies have gone bankrupt?
17922 MR. LAZZARATO: I think the appropriate question is how many have competed in our market space and, to my knowledge, none have competed in the markets we are in.
17923 MR. HENRY: But you felt it sufficient to point this out. Hasn't Rogers been making announcements --
17924 MR. LAZZARATO: Our security lawyers felt it sufficient to include that technology on the universe of potentially competitive technologies for purposes of debt prospectus.
17925 MR. HENRY: And your securities lawyers do that, of course, because it is important and --
17926 MR. LAZZARATO: -- and being an officer, I follow what our securities lawyers suggest.
17927 MR. HENRY: Right. And there is a reason for that, isn't there? That it has to give a realistic picture, it is not a marketing document.
17928 MR. LAZZARATO: It has to be a complete picture of what might happen.
17929 MR. HENRY: Right.
17930 MR. LAZZARATO: Not necessarily what is happening today, but what might happen over time.
17931 MR. HENRY: Right. And there have been no wireless companies -- there have been some buyouts, but the wireless companies are still actively competitive.
17932 MR. LAZZARATO: As far as I understand, yes, although there are -- I also understand some North American and Canadian wireless companies having a extraordinarily difficult time financing.
17933 MR. HENRY: As are many companies, including --
17934 MR. LAZZARATO: Especially in telecom, yes.
17935 MR. HENRY: Yes. And this also talks about anticipation of new technologies coming, as well, doesn't it?
17936 MR. LAZZARATO: Essentially cable would be a new technology as it pertains to public communications.
17937 MR. HENRY: And to your point about the various bankruptcies and so on, are you aware that the CRTC monitoring report indicates that most of the customers of the now defunct companies have ended up with the CLECs?
17938 MR. LAZZARATO: I was not aware of that and I would love to review it to understand it because my intuition would be that most of the customers would have ended up back with the incumbents because they see the failure of a competitor as demonstration that they had better return to the safety net of a incumbent. But I would be willing to review that and understand.
17939 MR. HENRY: Well, the Commission -- page 24 is the reference where the Commission found that.
17940 Now, I understand that under your proposal the ILECs would be required to impute to themselves tariff rates without the 70 per cent rate adjustment for essential services and Phase 2 costs for non-essential services, is that correct?
17941 MS MUIR: That's correct. Yes.
17942 MR. HENRY: Now, let's take an example of a residence service in Band B. And could you turn to an exhibit I handed out called Bell Residence Basic Local Versus AT&T Using Unbundled Loops.
17943 It is a bar chart.
17944 Do you have it? Okay. Now this is an example using Bell's Band B, and I know Bell has presented new cost information and these are the Commission's latest determined costs. So let's go with those for illustration purposes.
17945 Now, according to the Commission's determination, the ILECs loop costs, or Bell Canada's, I believe, in Band B, which is a non-essential band, is $10.26, which you see on the left-hand column, the cost portion, and the primary exchange cost is $12.49, so that means the extra costs to provide primary exchange service is $2.23.
17946 Now, the loop price, as they say in Band B, is $12.82. So as I understand it, under your proposal the CLEC could by the loop for $3.85 and that is shown on the right-hand column, correct?
17947 MS MUIR: Well, I am not sure it would work out to $3.85 because, as we have gone through a few times now --
17948 MR. HENRY: The incremental cost that we established, the incremental cost to you of an extra loop would be $3.85.
17949 MS MUIR: I don't even think I agree to that. But, anyway, for the purposes of this we will just go with your $3.85, but you realize you are looking at a broad basket. I am assuming that you are only using this to illustrate the imputation test.
17950 MR. HENRY: And I am illustrating to use your incremental cost. That is what your incremental cost would be $3.85.
17951 MS MUIR: Well, that would depend on the mix of services that I purchased with you. Again, I would have to go back to the aggregate basket of services, because it would depend on right today loops probably represent 4 per cent of our purchase. You would be applying it to the overall basket of services. So --
17952 MR. HENRY: Okay. Let's do it this way. You do that in one month you buy so many services --
17953 MS MUIR: Well --
17954 MR. HENRY: The very next month what would it cost you?
17955 MS MUIR: Pardon me?
17956 MR. HENRY: The very next month what would it cost you?
17957 MS MUIR: For all the services?
17958 MR. HENRY: No. For the extra loop you buy. You buy one more --
17959 MS MUIR: Well, the very next month -- I buy everything on a monthly basis.
17960 All I am saying to you is I don't think you can put it down to this level. The very next month if I added a loop, it wouldn't necessarily equate to 70 per cent off that one loop, if that's what you are suggesting.
17961 MR. HENRY: So you would not do a cost study, if you were looking at what the cost of that extra loop was?
17962 You are telling me that neither you nor your company nor any economist in your company would say the incremental cost of that is $3.85? Is that your evidence to the Commission?
17963 MS MUIR: I just don't even understand your question. Sorry.
17964 MR. HENRY: $12.82 is the price, our price. You buy one loop from us. Okay. One loop. I send you a bill for --
17965 MS MUIR: I am just asking you -- are you only talking about purchasing one loop, because if that's all, that's fine, but we wouldn't just purchase one loop. And loops only represent 4 per cent of our purchases.
17966 MR. HENRY: Okay. So we buy -- regarding the example where we buy one loop, your incremental cost is $3.85, correct?
17967 MR. LAZZARATO: That would be the price we would pay you.
17968 MR. HENRY: Yes. Your incremental cost --
17969 MR. LAZZARATO: I think it is not wanting to agree with your use of the word "cost", for all the reasons of the last two hours. But --
17970 MS MUIR: That would be our direct cost.
17971 MR. HENRY: Your cost to us, our price to you, $3.85 net -- our net price to you, $3.85, is that right?
17972 MS MUIR: Yes.
17973 MR. HENRY: I didn't think this was a difficult point.
17974 MS MUIR: I think it's because you don't really understand our proposal.
17975 MR. HENRY: No, I think it's because you don't understand your proposal, frankly; but let's keep going.
17976 So Bell in this example would have a price floor of $12.49, is that correct?
17977 MS MUIR: Are you referring now to the imputation test?
17978 MR. HENRY: Yes. The imputation test would have a price floor of $12.49.
17979 MS MUIR: Yes. That's right. It would apply -- what we are suggesting is it would apply the way it applies today.
17980 MR. HENRY: Now, if the CLEC had similar costs as Bell, not for the loop because you are getting the loop for less, but had similar costs in providing the additional component other than the loop, which to Bell cost $2.23, in my example -- in fact, it's a real example -- the CLEC would have a cost floor, assuming its cost was the same as Bell, of $3.85, plus $2.23, equalling $6.08, correct?
17981 MS MUIR: Can you just repeat that? Sorry.
17982 MR. HENRY: For this one loop you bought from us you would have a $3.85 cost for the loop, and if you were just as efficient as the ILEC and had $2.23 of additional costs, then you would add $2.23 to your bar of $3.85 and you would have a cost of what I had, $3.85, plus $2.23, to equal $6.08, correct?
17983 MS MUIR: Yes.
17984 MR. HENRY: Now, I did a little exercise to say, well, even if the CLECs costs were three times Bell's, so I took $2.23 times three, and I added it to the $3.85, the CLEC would still have a price floor of $10.57, still well below Bell's price floor of $12.49, is that correct?
17985 MS MUIR: Yes, under those assumptions.
17986 MR. HENRY: Okay. Let's take a hypothetical resale example. I wonder if you could turn, please, to a chart.
17987 MS MUIR: Excuse me, please. Are you just talking about the imputation test here, because that's what I thought you said at the beginning. I mean, that is the only reason I am discussing it on this basis with you.
17988 MR. HENRY: Well, it's both the imputation test and it also shows the amount of margin that you could play with, the amount of cost inefficiency.
17989 MS MUIR: No. Like, I wouldn't agree to -- that's why I asked for clarification. I think you said to me, yes, we are talking about the imputation test here. Did you not say that?
17990 MR. HENRY: Well, okay, let's talk about the imputation test.
17991 Under your imputation test, we would have to price at a rate much higher than yours, even if you had three times more the costs than us.
17992 MS MUIR: Okay. Now, we are for sure just talking about the imputation test, because I just agreed to all of this on that basis.
17993 MR. HENRY: Yes. Let's take that.
17994 MS MUIR: Are you asking me why did we think we should leave the imputation test in place as it stands?
17995 MR. HENRY: No, I am not. I just want to understand how it would work.
17996 MS MUIR: Well, I think I will just explain to you our thinking.
17997 MR. HENRY: Go ahead.
17998 MS MUIR: Yes, it would work that way, that if I accept the cost that you would impute would be your phase two cost, as you do today. And potentially there would be more margin than for the incumbent -- excuse me, for the entrant.
17999 But I guess the way we looked at it was typically the ILEC is the price leader and the entrants price position against the ILEC. So in order not allow the ILEC to abuse their dominant position in the market we propose that we would have an imputation test so that that would prevent some sort of downward spiral in pricing. So we would be able to maintain competition in the market without prices slipping down in line with the ILEC prices to meet us in the market.
18000 Because I guess this morning, even as Mr. Todder, Dr. Todder -- I am not sure -- was saying price is a big factor in someone's decision to change service provider. Although there are other factors -- and certainly we would like to compete on a basis of other factors -- price is certainly a significant factor, and, generally speaking, the competitor's price position in the retail market against the ILECs rates.
18001 MR. HENRY: Did we turn yet to the resale of hypothetical ILEC retail service under At&T proposal? I can't remember.
18002 MS MUIR: I am sorry.
18003 MR. HENRY: The chart called "resale of hypothetical ILEC retail service under AT&T proposal".
18004 MS MUIR: Is this an exhibit?
18005 MR. HENRY: No. This is the hypothetical one, not the one you just did. Have you got that one?
18006 MS MUIR: Yes. It's entitled "resale of hypothetical ..."
18007 MR. HENRY: Right. Now, we are going to do a resale example here. This is hypothetical. I just want to make sure I understand.
18008 Here we have the ILEC with $80 of cost and a 25 per cent markup for a price of $100.
18009 Now, the price to the CLEC, as I understand it -- I am going to assume -- so we cannot get into this argument again -- that you buy one of these. That's all you buy. The price to the CLEC would be $30, right?
18010 MS MUIR: Can you just explain to me what does the $80 represent here?
18011 MR. HENRY: The $80 is the ILEC cost.
18012 MS MUIR: So the $80 represents what it cost the ILEC to supply the service?
18013 MR. HENRY: Right. And the $20 is the markup the ILEC puts on it to get a $100 price. Now you come along and say, I want 70 per cent off that $100 price, so the wholesale cost to the CLEC becomes $30.
18014 MS MUIR: Right. Well, it's hypothetical you are saying? Because, I guess, really, the way we would look at this is if we flipped the title from the ILEC to the CLEC, and vice versa, I think that's really what we are arguing about here, whether we are asking you to buy something at $30 that cost you $80. I think what we would suggest is your margin is probably $70 and we are just asking to buy it at $30.
18015 MR. HENRY: Well, except that our price is $100 in that example.
18016 MS MUIR: I can accept your price is $100. I think where we disagree is what your costs are.
18017 MR. HENRY: Okay. And your costs -- the disagreement stems solely from this three line, paragraph 5.1 -- Table 5.1, three simple numbers, three zero four divided by four twenty one equals one seventeen -- that's your whole analysis on our cost structure, is that right?
18018 MS MUIR: Well, no. That is not our whole analysis. That is the end result of our analysis but we used our own cost structure. I mean, we would admit it -- we said, if we looked like you, so we actually analyzed our cost structure.
18019 MR. McLENNAN: The other analysis is on your cost structure, Mr. Henry, if I can, has to do with your overall returns in your utility sector which are so dramatically higher than they have been at the beginning of the price cap period and predicted to go even higher, one can only conclude that your overall costs have been declining very, very rapidly, or, as I said, you're accruing significant revenue at no cost attached to it at all.
18020 And, therefore, costs that are in this model, we have no idea how they relate back to the real costs in the company. But we can only believe that they are dramatically lower than they were a year ago, two years ago, three years ago. Your costs are declining very rapidly.
18021 That's why the fundamental question we had is, what is your cost.
18022 MR. HENRY: So you are suggesting that we have no retail service with only a 25 per cent markup?
18023 You keep coming back to the utility --
18024 MR. McLENNAN: I don't think I talked about your retail services with the 25 per cent --
18025 MR. HENRY: You talked about utility segment.
18026 MR. McLENNAN: I talked about we don't know what your costs are. That's all I have said.
18027 MR. HENRY: You said you don't know what our costs are for our utility segment, which has nothing to do with what we are providing you because there are a lot more things in there, would you not agree?
18028 When I hear you say that -- that was my very first question -- are you saying that the prices we provide to you would still cover their cost at a 70 per cent discount provided to you, or are you saying in aggregate with retail customers?
18029 I keep hearing two answers. I keep hearing you, Mr. McLennan, come back and say, oh, I look at the utility return and I assume that you are making lots of money, so I would just like to take some of it from your retail business and give it to my competitors; isn't that what you are saying?
18030 MR. McLENNAN: No, that is not what I am saying.
18031 What I am saying is the returns that you are making are so dramatically escalating that your costs for services that we are buying -- as a matter of fact, the costs across your entire business have to be declining very, very rapidly. Or, as I said earlier, you're accruing dramatic increases in revenue with no costs attached to it at all.
18032 And, therefore, when I stand back and look at the whole cost structure, I have no idea what your costs are. And, so, when we get prices based on cost estimates, I have no idea where they come from.
18033 MR. HENRY: If we can go back to my example, just to finish up. So the retail price of the ILEC was $100, the CLEC pays $30. So the CLEC has an input cost of $30 and a market price of $100 to compete with, right?
18034 MS MUIR: If you are charging $100, yes.
18035 MR. HENRY: So, in other words, unless the ILEC can reduce its cost from $80 to $30, the CLEC would always be able to undercut the ILEC in the market?
18036 MS MUIR: But I guess -- I think what we are suggesting, which you are not understanding or wanting to understand is, we believe your cost is really $30. So we don't have the ability --
18037 MR. HENRY: Okay. Is that it? That's the answer.
18038 MS MUIR: Sorry. I beg your pardon?
18039 MR. HENRY: If that's the answer, I am fine to move on. You think our costs are $30 --
18040 MS MUIR: I think from our analysis, all we are suggesting are two things: where we look at your aggregate returns, underlying those returns have to be significant cost reductions from where you started off. So your costs can't -- your cost structure doesn't really support the kind of rates you are charging us.
18041 So when we purchase a mix of retail and wholesale service in aggregate, we think you are overcharging us, because what we have to be able to get as, what it really does cost you to supply service to the end customer.
18042 So we are suggesting that in this hypothetical example, you are telling me about a service that cost $80, but it's not clear to me that you understand that we are suggesting, if you accept our evidence, it probably doesn't cost you $80.
18043 MR. HENRY: I now understand that. I have a hard time figuring out how three numbers prove that. Anyway, we will save that for argument.
18044 Let's look at --
18045 MS MUIR: Do you want us to explain line by line --
18046 MR. HENRY: Well, I think you have. We went through it earlier. I am prepared to move on to -- could you turn, please, to Centrax as a real live example, in terms of the chart, called "Bell's Centrax voice locals versus AT&T resale".
18047 Now, in that chart we have got the retail $38 low volume Centrax rate, as you can see in the left-hand bar, and under the AT&T proposal, if you bought one Centrax service from us, the CLEC would be able to purchase the $38 service for $11.40.
18048 We have also put on the high volume Centrax service in the next couple of bars, which shows the $21 if you buy in big bulk, you are already buying in a big discount of $21 retail, and if you got that rate at a 70 per cent discount, it would be $6.30.
18049 Now, can you confirm to me that when a CLEC purchases a large volume service, let's assume they had the $21 rate because they buy in large -- people like you, I'm sure, buy in large volumes. The CLEC -- the incremental cost to the CLEC of that would be $6.30. And that $6.30 that it takes, it can compete against the $38 price in the market because you buy in bulk and then sell to smaller customers.
18050 Is that correct?
18051 MS MUIR: That would be our direct cost based on --
18052 MR. HENRY: Right. You might have a few extra costs to add. I take that point.
18053 MS MUIR: Now, when you say "compete with you in the market," who do you price your Centrex Service to at $38?
18054 MR. HENRY: Small and medium enterprises, as do you, I'm sure.
18055 MS MUIR: Right. Except that we would buy this as one single access point and you would probably provide -- what do they get for $38?
18056 MR. HENRY: But you could buy a $21 service and piece it out to the $38 customers, could you not?
18057 MS MUIR: No, I'm asking you what the comparison is here. Is this a Centrex Service here, this $38?
18058 MR. HENRY: Yes. Yes, Bell Centrex Voice Locals.
18059 MS MUIR: For which --
18060 MR. HENRY: It's a pure resell.
18061 MS MUIR: For which Centrex Service though?
18062 MR. HENRY: Under a hundred locals.
18063 MS MUIR: Under a hundred locals.
18064 MR. HENRY: Yes. It's the $38 price. You would buy in bulk at $21. As you said you are a national customer, and you can certainly compete with the $21, but you can parcel it out to the small customers and compete with the $38 rate.
18065 And I take your caveat that you may have some additional costs of a help desk or something to add to that. I presume there are some small additional costs when you get something for $6.30 to resell you have a few administrative costs to add to it. Fair enough?
18066 MS MUIR: Well, we have all our SG&A costs which we don't allocate on a service by service basis. Okay, I'm just -- I just want to understand your question.
18067 MR. HENRY: Well, my question was: You could buy Centrex in large volume at $6.30 and compete with retail prices varying from $21 to $38?
18068 MS MUIR: Yes. So are you saying the price on the market is a lot higher than the cost to actually provide the service on the retail side? Yes, I suppose that is true.
18069 MR. HENRY: Or the cost to provide it at a 70 per cent discount in any event.
18070 I think we established that it is fair to assume that Bell's costs are greater than $6.30 in band B or at least the Commission thinks they are?
18071 MS MUIR: Yes, I don't think we established that, but you could say that.
18072 MR. HENRY: We have established that the Commission thinks that the loop cost alone is $10.25. So it would be pretty hard to imagine them thinking that the cost of Centrex was $6.30 in band B, wouldn't it?
18073 MS MUIR: I don't know what the cost is. I think we have been through this and I thought --
18074 MR. HENRY: Okay.
18075 MS MUIR: -- that you understood how we were talking about this.
18076 MR. HENRY: Do you honestly think it could be in the $6.30 range?
18077 MS MUIR: I actually have said I don't know what it is.
18078 MR. HENRY: Okay.
18079 MS MUIR: What we think from our analysis is the cost that you pay yourself to provide yourself with services to reach the end customer has to be far less than what you report your costs on a Phase 2 basis. There is no way to actually take all your Phase 2 costs and ensure that you are not duplicating some of your --
18080 MR. HENRY: Let me ask you, do you think your costs --
18081 MS MUIR: I'm sorry. You keep cutting me off there.
18082 MR. HENRY: I'm sorry.
18083 MS MUIR: There is no way that you could actually, unless you are willing to do a Phase 2 cost on all your services, right throughout your entire, and even then I'm not sure you could do it. But at least you would get an idea that you are not taking certain costs and allocating them more than one time so we are just disputing.
18084 Now, when you are pricing services to us so that we can go out into the competitive market, what we are really discussing here is what it costs you to supply yourself. And we are just trying to get to that level with our FBC rate.
18085 MR. HENRY: Do you think it costs you anything near approaching the $6 mark?
18086 MS MUIR: If you are just talking not counting our SG&A costs, because we don't allocate them on a product -- and we certainly wouldn't allocate them line by line. Yes, we would say it probably costs us less than that on average.
18087 MR. HENRY: Less than $6 to --
18088 MS MUIR: Yes, that is right.
18089 MR. HENRY: -- build a Centrex line?
18090 MS MUIR: Fully allocated in terms of all our costs because we don't allocate them right across. But if you are just talking line by line --
18091 MR. HENRY: Well, then why don't you build them?
18092 MS MUIR: Well, because -- but I'm sure that Mr. Lazzarato --
18093 MR. HENRY: If you are going to pay us --
18094 MS MUIR: Excuse me.
18095 MR. HENRY: Sorry. Sorry.
18096 MS MUIR: Mr. Lazzarato could probably explain better than I why we can't build them. We are trying to build them but there is -- to raise money to actually build an infrastructure, all of that takes time.
18097 So we have -- we have invested quite a few billions of dollars in building a network and even after making that investment we continue to have to purchase service from you.
18098 MR. HENRY: Mr. Lazzarato.
18099 MR. LAZZARATO: If I could add, the issue of raising capital is a much tougher issue than the issue of building facilities. The most profitable way for us to deal with customers today is on net access, our own network. Under our proposal, that will continue to be the most profitable way to deal with customers. It's where we control the service, where we have lower service and lower provisioning in customer service costs and we have better customer retention, keep your customers, you are going to be more profitable over time. So it will remain the most profitable method for us to access our customers.
18100 But as a CLEC, even one that has been around a little bit and who has the largest scale of any CLEC in Canada today, that is not something we can raise. We can't raise enough money to build -- rebuild a ubiquitous network like yourself or any other incumbent, even a small one.
18101 MR. HENRY: Okay. So let me understand what you just said.
18102 We give you a $6 rate. Nobody will give you money to buy it from us at $6. But if you --
18103 MR. LAZZARATO: I did not say that, but go ahead.
18104 MR. HENRY: Well, you said you had -- well, you said you could build it for $6. That was your cost. I just heard that.
18105 MR. LAZZARATO: I said we can't raise money fast enough to replicate a ubiquitous network in a short period of time.
18106 MR. HENRY: So how can you raise the money to pay us $6 if you can't raise money to build for $6.
18107 MR. LAZZARATO: Because we are -- when we get a service from you on a resale basis, we have already got a customer. As you know, when you put capital in place, that is on the prospective basis of getting customers in the future. A great business can narrow that time line down a little bit but that is an art.
18108 MR. HENRY: Okay. So to summarize, it is your evidence before this Commission that your costs are greater -- are less or equal to $6 or approximating $6.30 in band B? That is --
18109 MS MUIR: I think --
18110 MR. HENRY: -- is that your evidence?
18111 MS MUIR: No, that is not our evidence. I don't think we said that. I think what we said is not allocating below our direct costs. If we were to just provide service on that, we have a cost per line of on net. We take our total cost and just split it out per line. I believe that is less than $6 and whatever this is, 30 cents. But that is not -- we don't add in our SG&A on a per line basis. Like when you are running a business, we wouldn't actually look at our costs on a Phase 2 basis.
18112 MR. HENRY: Well, does our $6 include the SG&A?
18113 MS MUIR: Is that your loop costs?
18114 MR. HENRY: Well, do you think it does?
18115 MS MUIR: Actually I don't know your costs. I think we have been through this already.
18116 MR. HENRY: Last one thing to summarize.
18117 If you think your costs can approach $6, you still think the access to capital is a problem? If you can demonstrate the capital markets that your costs of serving this market are $6, do you think you would have problems of access to capital long term?
18118 MR. LAZZARATO: I think almost everybody in telecom that is not an ILEC as an access to capital issue today.
18119 MR. HENRY: I don't disagree. But I don't know one of them saying that their costs are $6.
18120 Anyway, do you?
18121 MR. LAZZARATO: Pardon me?
18122 MR. HENRY: Do you?
18123 MR. LAZZARATO: Do I which?
18124 MR. HENRY: Do you know any CLECs saying their costs to serve a Centrex customer is $6?
18125 MR. LAZZARATO: I have not heard any of our competitors cross-examined or submit evidence like that.
18126 MR. HENRY: You don't think if it was they might not have a lot easier access to capital at least in some times?
18127 MR. McLENNAN: No. Absolutely not.
18128 MR. HENRY: Okay.
18129 MS MUIR: I think that you misunderstood. Our cost to serve a Centrex customer is not less than $6. We are just saying our on-net cost of providing another access line is less than $6. I think you are confusing a few things here.
18130 MR. HENRY: I take it its your evidence that you would still have an incentive to build facilities if you could get these from us at $6.30?
18131 MR. LAZZARATO: Yes, we believe that.
18132 MR. HENRY: Now, you currently take $85 million worth of Centrex. Correct?
18133 MR. LAZZARATO: That is right. I think that is the number from the previous year 2000.
18134 MR. HENRY: And by my calculations with your proposal you could triple your Centrex purchases and still pay less than $85 million that you are paying now. I calculate $76.5 million.
18135 Now, if there was another facilities-based CLEC that has built its own facilities and has a strategy of servicing customers with its own facilities, that CLEC would have to have costs of our $6 to compete effectively against you. Correct? Wouldn't it?
18136 MR. LAZZARATO: It depends how you define "cost." I'm not sure we are on the same wavelength so far today on your definition of costs so carry on.
18137 MR. HENRY: I have got a CLEC out there who built its own facilities and I have a CLEC out there who is doing Centrex resell. A CLEC doing Centrex resell gets $6. There is another CLEC out there that has got all kinds of facilities in the ground and has costs of whatever. It would have to have costs of around $6 to be able to compete effectively, wouldn't it?
18138 MR. LAZZARATO: For the CLEC who is going to be -- who wants to do it on net instead of resell, is that your question?
18139 MR. HENRY: Yes. To promote facilities-based competition as you want to do.
18140 MR. LAZZARATO: Actually I think it could be just a touch higher than that. I mentioned two things a moment ago where we would continue to be incented to build our own facilities and have customers on our own network. One is that the initial provisioning and a continuing customer service cost associated with those customers is so much easier if we are managing the network as opposed to managing phone calls from customers and phone calls to an incumbent.
18141 Secondly, the simpler that customer experience is, the better the customer retention is going to be and the more your marketing and all your other costs actually pay off in the long run. The customer stays with you longer.
18142 MR. HENRY: Okay. Thank you.
18143 Now, in your evidence you discuss the 70 per cent discount and say that:
"... reducing the rates for competitor services by this amount will achieve a pricing effect comparable to structural separation." (As read)
18144 Do you recall saying that? I have a reference. I don't know if you want to go to it.
18145 MS MUIR: No, that is fine. Thanks.
18146 MR. HENRY: So let me understand this scenario. Under this scenario there would be a Bell wholesale company and a Bell retail company?
18147 MS MUIR: What scenario -- you are talking about under structural separation?
18148 MR. HENRY: Yes. Yes. The thing you are trying to emulate.
18149 MS MUIR: Okay. The part that we are trying to emulate, I haven't actually thought what does "structural separation" mean. What we are trying to emulate really is the parity that would exist or the neutrality in terms of accessing the network and getting the services and facilities that we get from you on the same terms and conditions that you get then.
18150 So what structural separation does is put all those in a separate entity so that each of us going to that entity to supply services to the end customer pay the exact same thing. So that is what we are trying to emulate.
18151 MR. HENRY: Now, is it your position that a separate incumbent local network provider that provides only wholesale services, the ones in your proposed competitor service basket, at rates that are 70 per cent less than current rates, would be financially viable?
18152 MS MUIR: Well, I'm not sure if you actually divested the rate structure would look essentially the same. Because you would lose a lot of the economies of scale and scope that exist from your ubiquitous network.
18153 Actually we didn't look at it that way. I wouldn't say that is our position or not. I don't think we have looked at it at all. But there are certain costs, obviously, associated with structural separation. What we are trying to get is that neutrality in terms of accessing the services so that it doesn't cost us significantly more to get those same services to go to the end customer as it costs you. I think that is really all we are trying to get at.
18154 MR. HENRY: But if you did that, wouldn't that wholesale company have to have a mark-up of at least 233 per cent just to cover its costs and then a mark-up again to cover its joint and common costs?
18155 MS MUIR: Well, you know, you are talking in a very hypothetical basis, this 233 per cent. But we are not actually, if you actually structurally separated and set up a whole different company to do this, there would be a different cost structure there too. Not the cost structure that you necessarily have today.
18156 MR. HENRY: So it wouldn't emulate it?
18157 MS MUIR: No, I explained to you what it would emulate. It would emulate the fact that there would be neutrality. There would be a level playing field. We would all get access to the services we need to provide service to the end customer on the same terms and conditions.
18158 MR. HENRY: Well, let me understand that neutrality.
18159 I assume that the structurally separate Bell retail, if I could call it that, would also pay the wholesale company rates that reflect the 70 per cent discount?
18160 MS MUIR: Well, I think the Bell retail, all I'm saying there is if you structurally separated it and if this entity had the network without any retail arm, whatever the prices that entity charged would be the same prices they charged to me as they charged to you.
18161 MR. HENRY: Okay.
18162 MS MUIR: Do I know what those prices are? Is that -- I mean I think you are just drawing the conclusion the prices would be the same, and I'm saying I didn't look at it. All we are saying that is when we talk about emulating structural separation. What we are talking about is access on the same terms and conditions.
18163 MR. HENRY: But I'm just trying to understand. Well, that is exactly my point that is troubling me.
18164 It would have access on the same terms and conditions and yet your imputation test gives the exact opposite effect. It doesn't give Bell retail when it's inside the company access at the same cost. It has an imputation test of the undiscounted rate. So I --
18165 MS MUIR: I don't think you are talking about access there though. I think when we are talking about the imputation test, we are actually talking about the retail pricing of the service as opposed to what the service costs the service provider.
18166 MR. HENRY: Well, would your --
18167 MS MUIR: Those are two different things I think.
18168 MR. HENRY: Would your structurally separated affiliate, I think you said in interrog, it would pay the same thing as anybody else, the retail arm?
18169 MS MUIR: No, but you are talking -- those are input prices to the retail arm that you would purchase. Let's say we are talking about you, Bell Canada retail, purchasing services from a structural separated wholesale network entity. You would pay the same to that entity --
18170 MR. HENRY: Right.
18171 MS MUIR: -- as I would pay.
18172 MR. HENRY: So if it is $30 in your example, we would pay $30 and you would pay $30.
18173 MS MUIR: Right.
18174 MR. HENRY: But under your proposal we pay $70 or $100 and you pay $30 under your imputation test. So I'm having trouble seeing how it --
18175 MS MUIR: Well wait, you are not -- wait. I think you are getting confused about what the imputation test does though. The imputation test is --
18176 MR. HENRY: We just went through them on the charts.
18177 MS MUIR: Yes, we did. But the imputation test is a cost you would have to impute.
18178 Are you asking me if you were really a structurally separated entity, would we do that imputation test proposal? One is a proposal that goes to what -- how you can price your retail services. That is why you have the imputation test.
18179 MR. HENRY: What I am saying is you said that your proposal would emulate structural separation, and what I am saying is the Bell retail under proposal cannot charge the same price that the Bell retail company can under structural separation. I do not see how it comes close to emulating structural separation. Can you enlighten me?
18180 MS MUIR: I'm not sure I understand what -- understood what you just said. I can repeat what I said. I'm not sure I'm going to be getting at what your difficulty is.
18181 When I talk about emulating structural separation, I'm talking about what -- we would all pay the same cost to get to the end customer in terms of the services that we purchase, different network elements and services that we purchase. And therefore, there would be a level playing field in terms of the cost structure of each organization.
18182 So what we would eliminate are what advantages the incumbent has because they are not starting to build a network at the same time as they are starting out in competition.
18183 MR. HENRY: So what would the structurally separate company have as an -- retail company have as an imputation test?
18184 MS MUIR: Well, we are not talking about structural separation so I didn't really think through it in those terms. We are talking about an actual integrated company. If you are saying that you have to impute a different cost than we may have, it's potentially right.
18185 What I said -- the reason we decided to leave the imputation test in place had to do with the position that the ILEC holds in the market as being dominant, as holding the majority of the market share and as being the price leader.
18186 MR. HENRY: I will accept that answer as close as we can get to understanding each other on this one.
18187 I want to turn to the financial impact of your FBC rate and ask you a few questions on that.
18188 Now, in your interrogatories you said that the impact of your proposal was about 575 million to the ILECs. I think you said five to six hundred and in one interrogatory you pinned it down.
18189 MS MUIR: Can you tell me which interrogatory that was, please?
18190 MR. HENRY: Yes, it was AT&T(The Companies)27.
18191 MR. HENRY: Now, I think we established that out of territory CLEC operations would qualify for the discount and you say in your evidence that you estimate the impact of your proposal.
18192 Did you find the 575 million?
18193 MS MUIR: Yes, I know what you are talking about. Yes.
18194 MR. HENRY: Yes.
18195 MS MUIR: I'm sorry. You said something just after that about --
18196 MR. HENRY: Just reminding us that we established that the out of territory -- I said CLEC -- I meant ILEC operations of -- well, CLEC operations of TELUS and Bell would qualify for the discount.
18197 Now, I believe you say in the interrogatory responses that the estimate of 575 million was based on the effect of the 70 per cent discount on services provided by the ILECs to AT&T, CallNet and GT?
18198 MS MUIR: That is correct.
18199 MR. HENRY: Is that correct?
18200 So this figure ignores the impact of the 70 per cent discount on services provided to other CLECs such as Microcell, TELUS' out of territory operations, Bell Intrigna or any other CLEC that may enter the market?
18201 MS MUIR: Yes, we just took an estimate. Actually even -- I mean we just looked at what we thought in aggregate those companies spent really on the basis of our spend. I don't have access to what TELUS spends.
18202 MR. HENRY: Okay. And under AT&T's proposal, resellers and Canadian carriers who are not CLECs would not be eligible for the discount. Correct?
18203 MS MUIR: That is correct.
18204 MR. HENRY: But AT&T could resell services such as Megalink and ISP link that it purchases at a 70 per cent discount to ISPs. Right?
18205 MS MUIR: I suppose they could although that wasn't part of the plan. I mean that --
18206 MR. HENRY: Well, do you not think that the ISPs would put you under a lot of pressure to pass on some of that discount to them, if not a good chunk of it? You get 70 per cent in a business they compete in. They are not allowed to get it. Do you not think rather than coming to Bell they would come to you and ask you to pass it on? You are a forborne carrier.
18207 MR. LAZZARATO: If I may, I think the -- you are asking if we would be a price leader, I think, is the implicit part of your question.
18208 MR. HENRY: Well, not just you. Any CLEC.
18209 MR. LAZZARATO: Well, I don't think that any of the CLECs that I'm aware of that are here represented at this hearing, have the affordability to be a price leader. So a customer may very well ask. Absolutely. I mean that is what customers are good at, trying to alter the value of proposition. But it would certainly not be our intention to take our kind of a proposal for facilities-based carrier rate and immediately reprice the market for one service or a group of services.
18210 MR. HENRY: And do you seriously expect the Commission to believe that?
18211 MR. LAZZARATO: That is what has happened in long distance in the last 12 months.
18212 MR. HENRY: Well, how about long distance --
18213 MR. LAZZARATO: Many people thought that when the contribution regime changed at the beginning of this year, that that would have a dramatic impact on who were the price leaders in LD. To my knowledge that has not had that impact. That impact or the fear of that has been unwarranted and the decline in LD pricing in the Canadian market, this year so far in 2000 compared to prior years, has not accelerated, which was the worst fear that certain economists had at that point a year ago.
18214 MR. HENRY: And don't get me wrong. I'm not accusing you or any one party. But all it takes is one party, isn't it?
18215 MR. LAZZARATO: No, I think it takes another one to follow too.
18216 MR. HENRY: Well and, Mr. McLennan, I'm sure you would remember what happened in the long distance market.
18217 MR. McLENNAN: That was some time ago, Mr. Henry.
18218 MR. HENRY: Yes.
18219 MR. McLENNAN: But I will do my very best. I will do my very best to try to remember.
18220 MR. HENRY: You remember the long distance discounts which were far less than what you are asking for and you don't think --
18221 MR. McLENNAN: In fact, I will tell you what I remember about long distance and I will tell you what I remember about the discounts.
18222 The company that I was leading at the time had to file tariffs. And I remember all of our competitors would go into our customers and look at our tariffs and then bid underneath the tariff price. I can remember standing up and saying, "Boy, we sure do need competitive neutrality in this marketplace going forward." It eventually came.
18223 So my recollection was one of being quite frustrated with pricing and tariffs and having to tariff and the new entrants not having to tariff and so those are some of my recollections.
18224 Would you like me to answer some other thoughts about long distance?
18225 MR. HENRY: Well, my point simply was --
18226 MR. McLENNAN: That is the competitive neutrality that I keep discussing I'm talking about.
18227 MR. HENRY: My point simply was that all it took was one, it doesn't have to be you, it doesn't have to be anybody in this room. It can be another CLEC to take one action, spend some of the discount and we are into some downward price spiralling.
18228 MR. McLENNAN: That is all possible. There has been several examples of some very -- at least a couple of very bad experiences in that area and if one was to repeat those examples they would be -- they would be hard pressed in the marketplace. I think there was a lot learned by a couple of those examples, and as Mr. Lazzarato said, with the contribution decision and the benefit that that bestowed, which was a great first step, we have not seen any of a similar type of price action in long distance since then.
18229 No CLEC in this country that I know of can afford to be a price leader.
18230 MR. HENRY: As I recall, no long distance entrant at the time could afford to be one either, but it happened. Do you not recall saying that?
18231 MR. McLENNAN: I think what I have just said to you is that lessons have been learned, and I know of at least one and I know of two. But you don't see any of the CLECs being price leaders in the marketplace today because they have no capacity to do so.
18232 I think I know the one you are remembering but maybe we are not remembering the same one. But lessons have been learned and nobody is repeating those mistakes.
18233 MR. HENRY: Well, I do remember occasions where competitors were accused of using terms like sustainable competition as a buzz word for government protection. Do you recall that?
18234 MR. McLENNAN: You know what, Dennis, I'm really glad you went back and looked at a lot of the speeches that I made because I did too and I remember that exact quote.
18235 And do you know I made a lot of other statements about sustainable and maintaining competition and I'm really glad you brought it up, because I am very, very satisfied that every time I was out -- and by the way, I made an awful lot more speeches than I thought I did, so it took me a lot longer than I thought it was going to take. But in fact, I am totally satisfied that every time I was making my points and making them quite strongly on occasion, I was always fighting for competitive neutrality. And competitive neutrality is precisely what I'm fighting for again here today.
18236 MR. HENRY: I guess it's all --
18237 MR. McLENNAN: So those are my recollections, Mr. Henry.
18238 MR. HENRY: I guess it is all in the eye of the beholder, isn't it?
18239 MR. McLENNAN: I don't know what that means but that is my recollection.
18240 So just to recap, I don't -- I think I heard you say in your $575 million you did not take into account any possible repricing of the market that you might face as a result of resellers coming to you and wanting to downprice or get some of the discount.
18241 MR. McLENNAN: Just one comment, Mr. Henry, on that. We have had several organizations come to us and want us to reprice as a result of contribution, and we have resisted that -- and resisted that strongly. We would resist again in this case.
18242 MR. HENRY: Ah, but the difference there is contribution applies to everybody. Now, in this case, you would have a 70 per cent discount advantage over everybody else, wouldn't you? A little bit different situation, wouldn't you say?
18243 MS MUIR: I wouldn't say we would have a 70 per cent advantage over you. Also, contribution didn't apply exactly equally to everybody because some parties did get to recoup some of the change in the contribution through rates and other parties did not.
18244 MR. HENRY: Okay. So it's your position that these resellers would just pay full freight and you would get the discount and none of that would get passed on. That's fine. I understand.
18245 MS MUIR: I think, actually, we didn't take a position. We just said we would not be leaders in a downward pricing spiral --
18246 MR. HENRY: Yes
18247 MS MUIR: -- and we have shown discipline in the market. As Mr. McLennan said, we have learned some lessons. There is natural dynamic in the market. That's all part --
18248 MR. HENRY: Right
18249 MS MUIR: -- of having competition.
18250 MR. HENRY: Don't get me wrong.
18251 MS MUIR: What we are talking about is --
18252 MR. HENRY: I'm not -
18253 MS MUIR: -- is actually -- I'm just pausing for a sec, so you don't have to feel like you have to jump in.
18254 What we are talking about is letting competition roll out. So if you are asking: did we actually try to figure out what impact that would have, no, but there would be changes in the marketplace. I don't think we would sit here and say nothing will change because that's what we hope will happen.
18255 MR. HENRY: And don't get me wrong. I wasn't suggesting any one party, but all it takes is one party. You would agree with that? All it takes is one party, a party who might not even be in the room today. A party who might start up tomorrow.
18256 MR. LAZZARATO: Mr. Henry, I think what you are trying to suggest is that one party, no matter how big or small, could take a pricing action and upset the whole price dynamic across the country. I would hazard to say that somebody would have to be large, have to make a significant price change and stick to it across the country for a sustained period of time, then I would be willing to take you point that somebody could make the change.
18257 Nobody in this industry, nobody that I'm aware of, that is coming into this industry, has the ability to do that, in my opinion.
18258 MR. HENRY: To the extent it were to happen, none of this is indicated or reflected in your $575 million, right, if it did happen?
18259 MR. LAZZARATO: To the extent it were to happen --
18260 MR. HENRY: Right.
18261 MR. LAZZARATO: -- I will give you that.
18262 MR. HENRY: Okay.
18263 Now, under your proposal, would non-CLEC carriers be able to register as CLECs to get the discount?
18264 MS MUIR: It's not registered as CLECs. You actually have to be operating as a CLEC.
18265 MR. HENRY: Right, not ubiquitously, but you are right, yes.
18266 MS MUIR: I just want to be clear you have to be a CLEC.
18267 MR. HENRY: Right, right.
18268 MS MUIR: Right. So if you become a CLEC, then you could get the discount.
18269 MR. HENRY: You have assumed, with a 70 per cent discount, that this might not attract even one more CLEC?
18270 MS MUIR: It might attract one more CLEC. I think we were just taking at this point in time.
18271 MR. HENRY: Right.
18272 MS MUIR: And maybe that would be good.
18273 MR. HENRY: So the 575 is underestimated to that extent, if there were more to come in?
18274 MS MUIR: If you are talking hypothetically, yes, but we were looking at what exists today and who spends with you --
18275 MR. HENRY: Right, three carriers.
18276 MS MUIR: -- today on a large-scale basis.
18277 MR. HENRY: How about large customers that own their own facilities, like hydro companies, could they register as CLECs and get the discount?
18278 MS MUIR: They would have to operate as CLECs.
18279 MR. HENRY: Right. Have you factored whether that might happen into your estimate?
18280 MS MUIR: No. I think it's pretty clear what's in our estimate. We looked at what the starting point would be.
18281 MR. HENRY: Okay.
18282 How about market share loss for the ILEC, have you factored that into your estimate?
18283 MS MUIR: Are you suggesting that market share loss will be directly linked to this?
18284 MR. HENRY: Do you expect market share loss to the ILECs as a result of this?
18285 MS MUIR: I would expect that our market share will keep growing, presumably as it's growing.
18286 MR. HENRY: And that this proposal would accelerate that. Correct?
18287 MS MUIR: Accelerate or not accelerate, that's difficult to say. We didn't actually look at that estimate. I think there should be -- our markets should keep growing. Without this proposal, I think what we are saying is we won't have an opportunity for competition to unfold.
18288 MR. McLENNAN: There is an interesting point, Mr. Henry, on market share loss, as we measure it today, in fact. When we use your facilities and require a customer and pay you the full retail rate based on whatever the cost structure is and the markup is and whatever, you, in fact, are getting full retail price for that. So you essentially haven't lost a customer in that scenario at all and we have acquired a customer. So there is a little bit of double counting going on when you talk about market share losses when you are talking about resale. So market share losses get to be a little bit confusing unless you really want to get into the detail of it.
18289 MR. HENRY: But in any event, you haven't taken into account any additional market share loss that you would get from this? And I presume you are proposing this proposal so you will get market share.
18290 MR. McLENNAN: You mean market share gain that we would make?
18291 MR. HENRY: Well, okay, yes.
18292 MR. McLENNAN: Hopefully, there would be some market share gain on our part, yes.
18293 MR. HENRY: Yes. And it's not reflected in your numbers?
18294 MR. McLENNAN: No, it isn't.
18295 MR. HENRY: Okay.
18296 Have you factored into your estimate that the impact of any downward pressure on retail and wholesale rates? You don't think there would be any?
18297 MS MUIR: I think I just said that probably the market will take on a different dynamic. We have certainly left open enough pricing flexibility in our proposal to do that. And maybe there would be natural downward pressure on prices.
18298 MR. HENRY: Right
18299 MS MUIR: But that's what competition brings and that's why having a proposal that rules out competition actually brings about efficiency improvements and other changes within each operator so that they can compete in the market. It doesn't allow one group of operators to rely on an advantage they have or cost-recovery from services that aren't really subject to that much competition.
18300 MR. HENRY: I agree with you that that's what 70 per cent discounts would bring: downward pressure on retail and wholesale, but I guess we can agree -
18301 MS MUIR: I don't think I said that. I don't think I said --
18302 MR. HENRY: You said that's what it -
18303 MS MUIR: I said that a 70 per cent -- I said there is a natural dynamic in the market and what we are trying to bring about is competition, which brings about a dynamic of its own. I don't think I said a 70 per cent discount will bring about market share loss and downward price pressure on retail services.
18304 MR. HENRY: Have you assumed any downward price pressure on retail?
18305 MS MUIR: No, we haven't assumed.
18306 MR. HENRY: Okay. Have you assumed any downward pressure on wholesale, like from Group Telecom or other carriers, or Videotron or other wholesale carriers? Have you assumed any downpricing?
18307 MS MUIR: No. As I explained to you, what that number represents is simply what we say --
18308 MR. HENRY: Right
18309 MS MUIR: -- in our interrogatory response.
18310 MR. McLENNAN: What we would in fact hope, without going into the detail of forecast implying, which we didn't do, on the assumptions there, but it would create, in fact, discipline in the marketplace, as opposed to discounting all over the place. And discipline is what this market needs.
18311 MR. HENRY: Mr. Chairman, I am about to head into a new section. I think it would take about 35 minutes, but I'm in your hands.
18312 THE CHAIRPERSON: You mean 35 minutes would finish your cross?
18313 MR. HENRY: Yes.
18314 THE CHAIRPERSON: Let's keep going.
18315 MR. HENRY: Thank you.
18316 Could we got to AT&T Exhibit No. 20? It's second quarter 2001 financial results.
18317 MR. HENRY: If I could ask you to turn to page 7.
18318 On page 7, I see the earnings before interest, taxes, depreciation and amortization six months ended June 30.
18319 MR. LAZZARATO: Yes.
18320 MR. HENRY: And I see that EBITDA has improved from $38 million to $57 million in 2001. Could you explain what accounts for that improvement?
18321 MR. LAZZARATO: I will summarize it, Mr. Henry, but this document actually does detail it as a quarterly discussion of MD&A. But, generally --
18322 MR. HENRY: Maybe I could shorten --
18323 MR. LAZZARATO: -- generally, some increase in sales, to the tune of about $25 million the first half of this year compared to the first half of last year, point one; point two, downward price pressures in some products, not dramatic price pressures but consistent with what we have seen the last few years, whether it's in data, local itself, LD, partly offset by the benefits of the change in the contribution regime from the beginning of this year.
18324 MR. HENRY: Right. In fact, I think page 1 says the EBITDA improvement was the result in a decrease in service costs from changes to contribution regime, which you just mentioned.
18325 The reduction in the direct rate last year, I guess would also contribute somewhat to that on a much less scale?
18326 MR. LAZZARATO: That's right.
18327 MR. HENRY: But this improvement would not reflect the reduction to the 800 database query charge from .63 cents to. 333 cents, which occurred in July, 2001. Right?
18328 MR. LAZZARATO: That's right. These are June 30 --
18329 MR. HENRY: Right.
18330 MR. LAZZARATO: -- financial statements.
18331 MR. HENRY: And it wouldn't reflect the local loop price reductions of the Commission either?
18332 MR. LAZZARATO: That's right.
18333 MR. HENRY: Now, if we go down a few more lines to a line called "Lost for the Period", we see that the opposite result occurs there. In six months, ended June 30th, 2000, there were $223 million of debt, increased to $359 million of debt. So I assume --
18334 MR. LAZZARATO: Mr. Henry, are you referring to the income statement and you said a minute ago "Loss for the Period", and you just used the term debt, so --
18335 MR. HENRY: I did. That was my mistake. I guess I combined my question with my -- is that primarily due to the increased debt load?
18336 MR. LAZZARATO: There are a couple of items there, but one is the increased debt to finance our network.
18337 If you look just below the EBITDA line that you were referring to earlier, you will see depreciation and amortization, which has increased from 182 in the prior year for the six-month period to $221 million in the current year for the six-month period, and that's obviously in relation to the assets that we have put in place over the course of the last number of years. By example, in 1999, we spent $720 million in capital expenditure; in the year 2000, approximately 500. And I, just off the top of my head, forget the amount we spent on the first half of this year, but I'm sure it's a little north of 200.
18338 MR. HENRY: If we flip back to page 6, the balance sheet, I see under June 30th of 2001, down in the bottom box, the long-term debt is about $4.3 billion. Have I got that right?
18339 MR. LAZZARATO: That's right.
18340 MR. HENRY: If we flip to page four of this document, under the --
18341 MR. LAZZARATO: Mr. Henry, if I may, just before you leave that page --
18342 MR. HENRY: Sure.
18343 MR. LAZZARATO: -- I think it's important to note that the long-term debt, one important measure of liquidity, but so I think probably to take a net position of debt and cash is even more appropriate. So the net position of debt and cash has changed from about $3.55 billion at the end of December to approximately $3.8 billion at the end of June, 2001. That's right. So the first part of this year, we did a lot of financing, when it was possible.
18344 MR. HENRY: Right.
18345 MR. LAZZARATO: We had to do it in the U.S. Our advisors advised us -- happened to be the same firm as your expert witness, Mr. Talbot -- that to raise money in Canada was absolutely out of the question this year, so we were able to raise it in the U.S. early this year.
18346 MR. HENRY: I understand as a result of that, I don't think you need to turn to it but I read on page 4 that you now have available liquidity of over $1.1 billion? I think I read somewhere that you expect to be fully funded till the middle of June, 2003?
18347 MR. LAZZARATO: That's right. But that's not fully funded -- just so you understand, that's not fully funded until we turn cash flow positive, as a business. That's fully funded to an important date in our company, which is a predetermined merger date, or second stage of a merger date, with AT&T. So that's an important date to our shareholders --
18348 MR. HENRY: Right.
18349 MR. LAZZARATO: -- and debtholders that we remain -- that we are funded up to that point. I would call that the first critical stage on the path to profitability.
18350 MR. HENRY: Right. Now, could you please turn briefly, please, to paragraph 6-7 on page 49 of your evidence.
18351 Do you have it?
18352 MR. LAZZARATO: Yes.
18353 MR. HENRY: The third sentence there says:
"Even after implementation of the FBC rate, AT&T Canada's EBITDA to revenue ratio would be 22 per cent as compared to 48 per cent, 47 per cent, 43 and 42 for MTS, Bell, Telus and Aliant respectively". (As read)
18354 I had promised you I would come back to that.
18355 If we could flip back to Table 5-1 again -- I told everybody not to put it away -- I just want to make sure I understand the 22 per cent.
18356 MR. LAZZARATO: Yes, Mr. Henry.
18357 MR. HENRY: Is the 22 per cent EBITDA margin that we just talked about based on column 3 of 5, Table 5-1 --
18358 MR. LAZZARATO: Yes, it is.
18359 MR. HENRY: -- the adjusted EBITDA of 338, and you divide that by the revenues of 1505? Is that how I get the adjusted EBITDA margin?
18360 MR. LAZZARATO: That's right.
18361 MR. HENRY: As I understand it, these numbers are based on the year 2000. Correct?
18362 MR. LAZZARATO: That's right.
18363 MR. HENRY: So these numbers being based on the year 2000 would not include the favourable impact on your EBITDA of several CRTC decisions, including the contribution decision, and as I understand it contribution will increase your EBITDA in 2001 by $80 million and another $22 million next year?
18364 MR. LAZZARATO: If you are talking about the separate stand-alone impacts of certain decisions, then certainly this year 2000 analysis does not include that. It also does not include the fact that ILECs are getting stronger in the market, are still the price leaders.
18365 So there are many factors that aren't included in any retrospective analysis.
18366 MR. HENRY: And it wouldn't include a full year effect of the Commission's reduction of the direct connect rate from 0.7 to 0.3 cents, would it?
18367 MR. LAZZARATO: As I said, it would not include a lot of things, and how they would net, I'm not sure.
18368 MR. HENRY: The ones I am talking about all act positively --
18369 MR. LAZZARATO: When you are talking it seems you are being a little bit selective in terms of you are listing three or four or five positive impacts as opposed to saying at the end of the year: What is the net effect of a few positive impacts in a few real world situations where, again for the sake of sounding like a broken record, there is a competitive imbalance out there that our proposal is trying to address?
18370 MR. HENRY: In fairness, Mr. Lazzarato, I am not suggesting that I am being selective, I am suggesting that you are.
18371 Mr. Grieve pointed out, and I could go through them, that there is about $320 million that, through Commission decisions, are already to your benefit, and you have just conveniently left these out.
18372 MR. LAZZARATO: Three hundred and twenty million?
18373 MR. HENRY: Yes. By the time you add up -- for the industry. Perhaps not for you, but for --
18374 MR. LAZZARATO: I know not for me. I would sleep better at night if that was for me!
--- Laughter / Rires
18375 MR. HENRY: All right. Three hundred and twenty million for the industry. And they are the things we have been talking about. By using 2000 you have excluded those.
18376 MR. LAZZARATO: No, absolutely not. We have used 2000 because it is the only year we have with which to use prospective looking information with which to demonstrate a change.
18377 By using a historical year, we have been able to freeze all the other assumptions, whether they are Commission-driven assumptions, whether they are market-driven changes. We think this is the best way. We can freeze the impact and just show the difference from one variable, one change of assumption, as opposed to a dozen or more.
18378 MR. HENRY: Certainly you would agree with me that those decisions would increase your EBITDA, all things being equal -- ceteris paribus.
18379 MR. LAZZARATO: I'm not sure of the last phrase you used. I will say all other things be equal, yes.
--- Laughter / Rires
18380 COMMISSIONER WILLIAMS: I confirm it's "all things being equal".
--- Laugher / Rires
18381 MR. LAZZARATO: If you can't trust a commissioner, who can you trust?
18382 Absolutely. All other things being equal, the impact of decisions the Commission has made this year will have a positive impact, yes.
18383 MR. HENRY: Okay. Thank you.
18384 Could you, please, turn to page 3 of your evidence, paragraph I-9.
18385 There you say:
"During the price cap period..."
18386 Do you have it?
"During the price cap period the prices to ILECs by competitors for services that allow them to compete have largely remained the same, while the retail prices for business services have steadily decreased. The resulting margin squeeze has made it impossible for competitive local exchange carriers to gain material market share or to approach profitability." (As read)
18387 We asked you an interrogatory about that to try to substantiate that claim. Your initial answer wasn't particularly responsive, but on October 11th the Commission ordered a supplemental response.
18388 I wonder if you could please turn to that. That is AT&T(The Companies)4. I think it was filed on October 11th, ordered on the 3rd.
18389 MR. HENRY: Do you have that? Okay.
18390 Over on page 3 of that response you show the price reductions for the top 10 services used by AT&T. I think you would agree that these 10 categories represent the vast majority of what you buy from the ILECs. Is that correct?
18391 MS MUIR: Yes, I guess so.
18392 MR. HENRY: Again, I think if you go to 4200, I get that they represent $384 million out of the 421, so about 91 per cent.
18393 On the "Total" line, you said that the weight the price changes in the 10 categories to get a weighted average price change of minus 4.8 per cent.
18394 So what you are saying there, as I understand it, is: Here are all the service you buy from the ILECs, and look at what they have done, they have lowered their rates by minus 4.8 per cent.
18395 Is that what you meant in your evidence when you said:
"Prices paid by competitors for services that allow them to compete have largely remained the same"? (As read)
18396 MS MUIR: Relative to the retail prices of the market for which they compete.
18397 MR. HENRY: Right.
18398 MS MUIR: So what we are saying in this interrog is that there is a reduction over the price cap period of 4.8 per cent for the services we purchase, and there was a decline of 17.6 per cent for the services, on a regional level, that were competing.
18399 MR. HENRY: Right. No, that was my understanding.
18400 Below that table you make the point you just made:
"AT&T Canada notes that over the same period Bell Canada's business service rates have declined by 17.6 per cent and other cap services 12.6 per cent, as shown in CallNet interrogatory." (As read)
18401 Again, that is what you meant in your evidence when you said that retail prices have steadily decreased.
18402 MS MUIR: Retail prices were falling faster than the prices the ILEC charges us for the services we need to compete.
18403 MR. HENRY: Right.
18404 MS MUIR: That is what we meant by a "price squeeze".
18405 MR. HENRY: So you think that is a fair comparison, the minus 4.8 and the 17.6, to illustrate the margin squeeze?
18406 MR. HENRY: Okay.
18407 I was a bit confused by some of the lines in your table, so maybe you can help me understand how they were computed.
18408 That table on page 3. I would like to take line 3, for example -- that is "Direct Connect".
18409 As I recall, the direct connect rate went from 0.007 cents to 0.003 cents in March of 2000, which by my calculation is a reduction of 57.1 per cent, but you show a reduction of 20.4 per cent.
18410 Could you tell me why we get different numbers?
18411 MS MUIR: I guess there are a couple of factors. Switching and aggregation has direct connect and access tandem.
18412 MR. HENRY: I think they are separate lines.
18413 MS MUIR: You are right.
18414 It's just a timing issue. I think you gave the date when the price change came into effect.
18415 MR. LAZZARATO: Mr. Henry, if you look at the title on the column on the right-hand side, being a multi-year period --
18416 MR. HENRY: Right.
18417 MR. LAZZARATO: "Percentage change" is the annual change, whereas you are calculating a point in time change I believe.
18418 MR. HENRY: Yes, I am.
18419 So "toll-free dip" would be the same thing. My understanding again is that it declined from about half, but you get a reduction of 12.6. That is the same explanation, that the drop occurred later in time?
18420 MR. LAZZARATO: I believe so.
18421 MR. HENRY: Let me just try to explain this more simply.
18422 What I understand you have done is if a service was reduced by 40 per cent, at the start of the 4th year you would give it a weighted per cent reduction of 10 per cent. Correct?
18423 MS MUIR: Yes, for the time period that it was in effect during the price cap period.
18424 MR. HENRY: But when you go down to the retail prices, 17.6 and 12.6, those aren't weighted at all, are they?
18425 MS MUIR: No. That's right. That's an annual price.
18426 MR. LAZZARATO: We are comparing that annual change of 17.6 to the average annual change of 4.8, appreciating the 4.8 didn't happen consistently in every 12-month period within the period of time represented by the title.
18427 MR. HENRY: Yes. Nor did the 17.6.
18428 MR. LAZZARATO: That's right.
18429 MR. HENRY: It happened.
18430 MR. LAZZARATO: That's right. There is not enough paper to submit all the price changes on every product and every period of time so you take some averages.
18431 MR. HENRY: You could have done a weighted one on the bottom or you could have done the other one the same way.
18432 Can you tell me what the weighted average price decrease is, comparing current prices for these services that existed 1/1/98. In other words, can you do for me in the column for the prices for the services you bought the same thing you did for the retail services. Do you know what the number is?
18433 MS MUIR: No. Actually, it is on the retail side. If you tell us what the price reduction is on that same basis we can make the comparison, because we only have the average price for you.
18434 MR. HENRY: But I'm talking about the price changes --
18435 MS MUIR: Yes, you are talking about my price changes. Assume they happened at the beginning of the period.
18436 MR. HENRY: Instead of 4.8, just take the prices when they went in and what the average price is, just like you did with the 17.6. You said it was priced $100, dropped to $75. You call that a 25 per cent price reduction in the retail. Right?
18437 MR. LAZZARATO: Mr. Henry, would that --
18438 MR. HENRY: Do the same for me on the others.
18439 MR. LAZZARATO: Would that not go against the grain of one of your expert witnesses, who I believe was an economist, who was saying that everything should be analyzed over longer periods of time?
18440 MR. HENRY: Then why didn't you analyze the 17.6 and the 12.6 per cent over the longer period?
18441 MS MUIR: Can you just rephrase what you are asking us? To take the annual --
18442 MR. HENRY: Okay. My information is -- and we can get this from the record I think. We can estimate it from the record, but you can, I'm sure, do this more precisely than us.
18443 My information is, if you do the 4.8, the minus 4.8 reduction that you say were the reduction in prices we charged you --
18444 MS MUIR: Do you have a problem with this?
18445 MR. HENRY: Yes.
18446 MS MUIR: Okay.
18447 MR. HENRY: Let me try it.
18448 MS MUIR: I'm glad you are clear about that.
--- Laughter / Rires
18449 MR. HENRY: My information is that when we try to duplicate your minus 4.8 on the same basis that you did the 17.6, we get something like 22 per cent. In other words, your prices went down 22 per cent while these prices went down 17 per cent. Because you admitted you did them on two different basis.
18450 Don't accept my number. Could you do it?
18451 MS MUIR: Sure. I guess we can.
18452 MR. HENRY: In any event, I think we have established that we are comparing apples and grapefruit.
18453 MS MUIR: I think, no, we are comparing average and annual -- average over the period and this one is an annual. Is this what you are saying?
18454 MR. HENRY: Well, no. Yours is just a straight price drop. The 17.6 is just a --
18455 MS MUIR: I'm actually talking about the 4.8. That is the average over the period, and you are saying the other one is an annual.
18456 MR. HENRY: Yes. To take my example --
18457 MS MUIR: That's fine.
18458 MR. HENRY: Your 17.6 is the price drop from the beginning of the price cap period to the end. So if a price was $100 at the beginning of the price cap period, you are saying: Gee, it is now 83 per cent, or it has declined by 17.6 per cent.
18459 But in yours, you took your prices and didn't look at today's price and say it has declined by that much, you took a weighted average over the number of years. So that in my example, if a service was reduced by 40 per cent, instead of saying 40 per cent you say -- that was done in Year 4 -- you say it was 10 per cent.
18460 So I'm asking you to construct your table, your column, to make it comparable to the 17.6. As I say, my information is it is probably in the neighbourhood of 22 per cent. Don't you think that is just a little unfair comparison?
18461 MS MUIR: I don't think we were trying to be unfair, and I have undertaken to do that calculation. We will have a look at it.
18462 MR. HENRY: Okay. Fine, thank you.
18463 I think I'm down to the home stretch, Mr. Chairman.
18464 The other day -- one more last exhibit -- your counsel reviewed with The Companies' panel some stock prices of BCE. I want to explore your stock price compared to BCE's a little bit with you. One chart left.
18465 Have we got that stock price chart?
18466 MR. LAZZARATO: Yes.
18467 MR. HENRY: Now, I was interested. This kind of plots the movement in stock price of AT&T and BCE since the Nortel spin-off. I see AT&T Canada's stock price has been fairly stable over that period. I was wondering if that had something to do with the relationship with AT&T Corporate. Perhaps, Mr. Lazzarato, you could explain that phenomena.
18468 MR. LAZZARATO: It absolutely has everything to do with the commitment that AT&T Corp made a little over two years ago, to either buy the rest of this company at some future date or to auction it off and guarantee the public shareholders, equity shareholders, a certain return on their investment.
18469 I will try to do this in one minute, Mr. Chairman, to explain what we affectionately call the back end.
18470 To say it is a unique circumstance is an understatement. To my knowledge, it is the only company, public company, in North America with such an equity structure.
18471 When MetroNet and AT&T Canada long distance services merged in 1999, AT&T ended up owning what was allowable under foreign ownership rules at the time, approximately 31 per cent, but made a commitment to the then former MetroNet shareholders to buy the rest of the company if, and when, the rules changed -- foreign ownership rules changed. They agreed at that time that the price to be paid would be the greater of either a fair market value, to be independently calculated by some evaluators, or a specified floor price accreting at 4 per cent a quarter.
18472 Our stock price today very much represents that back end agreement, as we call it. As your expert witness Mr. Talbot has said in some of his public research on our company -- and I'm paraphrasing, but I could be very specific if you would like -- if it wasn't for that merger agreement and the provisions relating to the back end, as I called it, our stock price would very much reflect the stock prices of all other CLECs in North America over the course of the last two years.
18473 Most CLECs in North America, Canada and the United States, have seen -- on the equity side, have seen their stock prices drop somewhere between 80 and 90 per cent. Our stock today, and for the last number of months and quarters, has been trading essentially on that floor price that acrets at 4 per cent a quarter, as opposed at the intrinsic fair market value of the business. I think that's a phrase that Mr. Talbot has used in his public research.
18474 MR. HENRY: Right.
18475 MR. LAZZARATO: So it reflects the commitment that AT&T has made to the public shareholders.
18476 I think it's important to know that when AT&T makes good on that commitment and, literally, spends billions of dollars to buy the rest of this company at some point in the future, that's an exchange of money between AT&T and public shareholders; that is not money that comes into this company's coffers or improves the liquidity at all. It's a transaction between parties outside of this legal entity, obviously.
18477 MR. HENRY: Exactly.
18478 MR. LAZZARATO: So I don't want anybody to think that's a guaranteed future funding event. Absolutely not.
18479 MR. HENRY: No, I understand.
18480 What would the value of the buy out in 2003 be, do you know? About $6 billion, something like that?
18481 MR. LAZZARATO: The floor price that AT&T has committed to, you mean?
18482 MR. HENRY: Yes, in 2003. My information is -- well, it's about $60.
18483 MR. LAZZARATO: It's about $60 a share Canadian. And you are safe to assume about 100 million shares held by the "public shareholders".
18484 MR. HENRY: And today, if they bought it out today, it would be in the $4.5-billion range, something like that?
18485 MR. LAZZARATO: Roughly, yes.
18486 MR. HENRY: So unless you can improve your performance, AT&T Corporation would have to pay about this $4.5 to $6 billion to acquire a company that currently has about $4.3 billion in debt. Correct?
18487 MR. LAZZARATO: Minus $500 million in cash, right?
18488 MR. HENRY: Right.
18489 MR. LAZZARATO: That's right.
18490 MR. HENRY: Okay.
18491 MR. LAZZARATO: I think when a company buys another company or makes an investment, you are buying the ability to generate future business, generate future cash flow. They don't necessarily think of it as buying debt.
18492 MR. HENRY: Right.
18493 Any improvement in your performance in this time will reduce the amount of AT&T Corp's exposure. Correct?
18494 MR. LAZZARATO: I'm missing your point on that one, I'm sorry.
18495 MR. HENRY: Is there much -- I think you said there is not much chance the stock price is going to move up --
18496 MR. LAZZARATO: I did not say that.
18497 MR. HENRY: -- between now and then.
18498 MR. LAZZARATO: I did not say there is not much chance the stock price is going to move up. I would like that to be very clear.
18499 MR. HENRY: Is that what most of the investment houses are saying?
18500 MR. LAZZARATO: That might be what they are saying. I did not say that.
18501 MR. HENRY: Okay, I'm sorry.
18502 How much net income do you think that AT&T Canada would have to earn to justify a stock price of $60 in the absence of this obligation of AT&T Corp?
18503 MR. LAZZARATO: The way that CLECs historically, today, and even over the last four years, have been valued have not been on the basis of net income. I know incumbents sometimes are valued on a basis of a multiple of net income. But that's not a measure that AT&T Canada has ever been valued on, so I don't think that's a metric worth going to.
18504 MR. HENRY: Okay.
18505 MR. LAZZARATO: What we are trying to do is improve the business model here, Mr. Henry, not only for ourselves and all of our shareholders, but for all of the competitors in Canada. We are not representing the interest of any one shareholder; we are representing the interest of all of our shareholders and all of our debt holders.
18506 MR. HENRY: Okay. I have one last question. If you could turn to The Companies(CRTC)4200, page 6.
18507 MR. HENRY: Do you have that, The Companies(CRTC)4200, page 6?
18508 MS MUIR: Page 6?
18509 MR. HENRY: Page 6, yes. Have you got that?
18510 MS MUIR: Yes, I have it.
18511 MR. HENRY: Make sure I have the right reference, is there two quotes on the page?
18512 MS MUIR: Yes. One of the quotes probably starts on the bottom of page 5.
18513 MR. HENRY: The one I have is the second quote. It starts, "The FCC's theory". Do we have that?
18514 MS MUIR: Yes.
18515 MR. HENRY: Okay, we are on the right page.
18516 This is a quote from the precursor group. I just wanted to read it and ask you a question on it. This was the precursor group in the U.S. commenting on the outcomes of the Telecom Act in the U.S., and said the following:
"The FCC's theory was the below-market prices would jump-start resale competition because the incumbent telco would subsidizing their competitor's entry into the market. The problem with these teletopian below-market prices that they knee-capped any real market incentive to build competitive facilities from the start. Thus, the Telecom Act largely became a government entitlement program, where regulators reallocated share from market-rich incumbents to market-share-poor competitors." (As read)
18517 Of course, in the U.S. situation, you are not aware that CLECs get anything like a 70 per cent discount off retail, are you?
18518 MS MUIR: No, I'm not aware of a proposal that looks like ours anywhere else.
18519 MR. HENRY: Do you think this same criticism could be applied to AT&T's proposal, in this case?
18520 MS MUIR: Actually, I don't necessarily totally agree with what they are saying here, first of all. But all we are trying to do is get at the incumbent's cost of self-supply, as we have said earlier, so that there is some kind of neutrality in the market so that there would be an opportunity for facilities-based competition to roll out. Because right now how facilities-based competition has rolled out thus far is through what we call a hybrid approach, where we are talking about new entrants investing in facilities while simultaneously purchasing services from the incumbent. I think that will probably help competition rollout.
18521 I think also, though, the precursor talks about size and size mattering. Like, you took one little piece because that's in Attachment 2 of your response to this interrogatory --
18522 MR. HENRY: Yes.
18523 MS MUIR: -- and so there is a little more here than just that one quote. I don't necessarily think -- I guess, fundamentally, what I would take away from what's in the precursor group is they are almost saying it's impossible for there to be facilities-based competition. But they certainly do -- when they say "economic rules" in the first bullet, I mean, they are talking about just about the size of the incumbent and the fact that they have been able to build out a ubiquitous network. Essentially, they seem to be just abandoning the idea that this is at all possible.
18524 MR. HENRY: Thank you, panel.
18525 Mr. Chairman, those are all my questions
18526 THE CHAIRPERSON: Thank you, Mr. Henry.
18527 Some day I would like to hear you and Ms Muir do a "Who's on first" routine!
18528 Mr. Secretary, I understand we have a few exhibits to enter.
18529 MR. SPENCER: Yes. Thank you, Mr. Chairman.
18530 I have 12 documents.
18531 The first document, The Companies response to undertaking requested by ARC et al, transcript reference Volume 3, paragraph 4272 and Commissioner's Cram, transcript reference Volume 4, paragraph 6872, would be introduced as The Companies Exhibit No. 51.
EXHIBIT NO. THE COMPANIES 51: The Companies response to undertaking requested by ARC et al, transcript reference, Volume 3, paragraph 4272 and Commissioner Cram's transcript reference, Volume 4, paragraph 6872
18532 MR. SPENCER: The Companies response to CRTC Exhibit No. 30 will be The Companies Exhibit No. 52.
EXHIBIT NO. THE COMPANIES 52: The Companies response to CRTC Exhibit No. 30
18533 MR. SPENCER: Response to undertaking requested by Commission Counsel, Ms Moore, transcript reference Volume 2, paragraph 3319 will be The Companies Exhibit No. 53.
EXHIBIT NO. THE COMPANIES 53: Response to undertaking requested by Commission Counsel, Ms Moore, transcript reference Volume 2, paragraph 3319
18534 MR. SPENCER: Short form prospectus will be The Companies Exhibit No. 54.
EXHIBIT NO. THE COMPANIES 54: Short form prospectus
18535 MR. SPENCER: Bell residence basic local versus AT&T using unbundled loops, The Companies Exhibit No. 55.
EXHIBIT NO. THE COMPANIES 55: Bell residence basic local versus AT&T using unbundled loops
18536 MR. SPENCER: Resale of hypothetical ILEC retail service under AT&T proposal, The Companies Exhibit No. 56.
EXHIBIT NO. THE COMPANIES 56: Resale of hypothetical ILEC retail service under AT&T proposal
18537 MR. SPENCER: Bell Centrex voice local versus AT&T resale will be The Companies Exhibit No. 57.
EXHIBIT NO. THE COMPANIES 57: Bell Centrex voice local versus AT&T resale
18538 MR. SPENCER: AT&T Canada and BCE historical share price, The Companies Exhibit No. 58.
EXHIBIT NO. THE COMPANIES 58: AT&T Canada and BCE historical share price
18539 MR. SPENCER: We also have Aliant response to Question No. 1 of CRTC Exhibit No. 4, which will be Aliant Telecom Exhibit No. 6.
EXHIBIT NO. ALIANT TELECOM 6: Aliant response to Question No. 1 of CRTC Exhibit No. 4
18540 MR. SPENCER: Aliant response to Question No. 2 of CRTC Exhibit No. 4 will be Aliant Telecom Exhibit No. 7.
EXHIBIT NO. ALIANT TELECOM 7: Aliant response to Question No. 2 of CRTC Exhibit No. 4
18541 MR. SPENCER: Aliant response to Question No. 3 of CRTC Exhibit No. 4 will be Aliant Telecom Exhibit No. 8.
EXHIBIT NO. ALIANT TELECOM 8: Aliant response to Question No. 3 of CRTC Exhibit No. 4
18542 MR. SPENCER: Finally, Aliant response to Question No. 4 of CRTC Exhibit No. 4, Aliant Telecom Exhibit No. 9.
EXHIBIT NO. ALIANT TELECOM 9: Aliant response to Question No. 4 of CRTC Exhibit No. 4
18543 MR. SPENCER: Thank you
18544 THE CHAIRPERSON: Thank you, Mr. Secretary.
18545 That, then, will conclude our work for the day.
18546 We will see you tomorrow at 9:00 a.m., where TELUS, I believe, will be up next.
18547 So we will see you tomorrow at 9:00 a.m.
--- Whereupon the hearing adjourned at 1734, to resume
on Tuesday, October 16, 2001 at 0900 / L'audience
est ajournée à 1734, pour reprendre le mardi
16 octobre 2001 à 0900
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