**********************Important note:************************ If you are accessing this document via the Internet, please note that the Washington Utilities and Transportation Commission is not using the Internet or any other on-line network for taking formal comments on the Notice of Inquiry (NOI). Written comments, should contain the NOI caption and docket number, and should be submitted to Steve McLellan, Commission Secretary, not later than January 31, 1994. The Commission requests that commentors file an original and four copies of written comments. Additionally, at the time of filing written comments, the Commission requests that the comments be provided on a 3 1/2 inch, high density "floppy" diskette, formatted in either ASCII or WordPerfect (5.1 or earlier versions). The staff of the commission wishes to express its sincere appreciation to the University of Washington for sponsoring the posting of this Notice of Inquiry and allowing the use of its facilities toward this end. **********************End of Note*************************** December 3, 1993 Re: Notice of Inquiry on a Successor Alternative Form of Regulation for U S WEST Communications, Inc. Docket No. UT-931349 TO ALL INTERESTED PERSONS: In its Twentieth Supplemental Order in Docket Nos. U-89-2698-F and U-89-3245-P, entered September 3, 1993, the Washington Utilities and Transportation Commission (Commission) directed its Policy and Planning Section to prepare a notice of inquiry (NOI) relating to a successor to the existing U S WEST alternative form of regulation (AFOR). In response to that directive, the Policy and Planning Staff (Policy Staff) has prepared the attached discussion paper which explores technological, market, and regulatory trends in the telecommunications industry. The discussion paper then proposes a number of principles and guidelines for a new regulatory model. To initiate the NOI, the Commission solicits comments from interested persons on the discussion paper. In particular, the Commission seeks focused responses to the following questions: 1. What should the successor AFOR for U S WEST look like? In particular, are changes in corporate structure needed to enhance competition, protect monopoly ratepayers, and allow market forces to guide technology deployment? 2. Will changes in current depreciation methods be needed in the context of increased competition and alternative forms of regulation? If so, can monopoly ratepayers be protected from subsidizing the competitive ventures of the regulated firm? 3. What are the rules, laws, ratemaking policies, and structural changes necessary to facilitate transition to an effectively competitive local exchange marketplace? How does a successor AFOR plan fit into this transition? Notice of Inquiry Docket No. UT-931349 Page 2 4. Can any of the regulatory mechanisms adopted in the aftermath of the AT&T divesture be appropriately used to facilitate competition in local exchange markets? What competitive benchmarks can be used to evaluate reduced regulation of local exchange companies? 5. How do we promote widely available and affordable telephone service in a competitive environment? 6. What consumer protection regulations does the Commission need to retain as competition develops? 7. Do the policy elements identified by Policy Staff's paper encompass the core issues the Commission should consider as it evaluates a successor to the US WEST AFOR? What other issues and concerns should be considered, and what recommendations can be put forth to address them? Written comments, bearing the above caption and docket number, should be submitted to Steve McLellan, Commission Secretary, not later than January 31, 1994. The Commission requests that commentors file an original and four copies of written comments. Additionally, at the time of filing written comments, the Commission requests that the comments be provided on a 3 1/2 inch, high density "floppy" diskette, formatted in either ASCII or WordPerfect (5.1 or earlier versions). For more information regarding the Policy Staff's discussion paper, please contact Tim Sweeney, Policy Planning Office, at (206) 586-1123. After evaluating the requested comments, the Commission will schedule further proceedings in this docket. Sincerely, Steve McLellan Secretary ALTERNATIVE REGULATION OF U S WEST: TOWARD A NEW PARADIGM Joe Hommel Tim Sweeney Policy and Planning Office Washington Utilities and Transportation Commission Olympia, Washington December 1, 1993 BACKGROUND The Washington Utilities and Transportation Commission's (Commission) Twentieth Supplemental Order [1] in Docket Nos. U- 89-2698-F and 3245-P modified the original alternative form of regulation ("AFOR") [2] for U S West Communications, Inc. and directed the Policy Planning Office ("Policy Staff") to prepare a Notice of Inquiry ("Notice") exploring a successor to the modified AFOR. On January 16, 1990, the Commission entered the Fourth Supplemental Order in those dockets which adopted the original AFOR plan for U S West that: * Initially reduced rates by approximately $65 million. * Caps residence, business and carrier common line charges at 1989 levels for the plan's five-year term: January, 1990 to December 31, 1994. * Sets a range rate of return of 9.25% to 11.00%. * Permits rate increases for the company if earnings fall below 9.25% and requires that earnings in excess of 11.0% be shared with ratepayers. * Prohibits automatic rate banding or detariffing. * Returns 100% of excess earnings above 11.00% to ratepayers if such earnings are due to tax, accounting or separations changes. * Requires universal one-party service availability throughout U S West territory by December 31, 1994. * Requires monthly service quality reports. * Prohibits mandatory measured service during the term of plan. * Provides for monitoring and review of the plan and enables the Commission to rescind the plan under certain conditions. The U S West AFOR was implemented in accordance with RCW 80.36.135, which allows the Commission to regulate a telecommunication company, previously subject to traditional rate of return, rate base regulation, under an alternative form of regulation that is more tailored to the individual circumstances of the company and its ratepayers. On August 25, 1992, after approximately two and one-half years of experience with the U S West AFOR, the Commission exercised its option under the plan to initiate a proceeding to determine whether the public interest justified modification or termination of the AFOR. Following a lengthy review of the AFOR, including multiple rounds of comments by interested parties and consideration of formal testimony, the Commission issued the Twentieth Supplemental Order. This order provided that, in order for the AFOR to continue in effect until its termination date of December 31, 1994, it be modified in several ways, including: * An adjustment to the earnings sharing formula which increases the ratepayers' share of those excess revenues that are easiest to achieve, while increasing the company's share of revenues that are more difficult to reach. * A requirement that U S West annually demonstrate satisfactory compliance with the Commission's telecommunications quality of service rules. * A clarification that the Commission may refund the ratepayers' share of excess revenues through rate restructures that include permanent rate design changes and permanent price reductions. * A requirement that interest accrue at the customer deposit rate on the ratepayers' share of excess revenues from the conclusion of each plan year until such funds are actually distributed. * Expansion of the definition of exogenous cost changes [3] beyond the tax, accounting and separations costs in the original AFOR agreement, to encompass cost reductions attributable to independent telephone company access charge decreases. Cost decreases that produce continuing savings, such as reductions in the corporate income tax rate, pass through to consumers 100 percent in remaining sharing periods. U S West accepted the modifications on October 29, 1993. [4] The company indicated that, while it was accepting the plan as being marginally better than traditional rate of return regulation, the modified AFOR would not be suitable in an environment of accelerating competition. The company suggested that further resources should not be expended on the modified plan, but directed to development of a successor AFOR. OVERVIEW As Appendix 1 discusses, the U S West AFOR was designed to address perceived shortcomings in rate base, rate of return regulation as applied to local exchange telecommunications companies. In particular, the Commission was concerned that traditional regulation did not provide companies with adequate incentives for efficiency, did not recognize competitive changes in the industry, and did not allow subscribers to promptly share in cost reductions realized by the companies. At the same time, the Commission was committed to ensuring ongoing protection of monopoly customers and the development of robust competition in telecommunications markets. While competition is increasing in certain telecommunication markets, there may be an extended transition to effective competition across all markets. Working through this transition -- and supporting the development of effective competition -- will be difficult and controversial. Policy staff believes that a fundamental restructuring of regulation may be needed, one that attempts to shrink the number of services regulated, while ensuring that core services remain reliable, affordable, and widely available. Policy Staff generally agrees with U S West that a fresh approach toward achieving an incentive-based regulatory framework is in order. Our view is that a new regulatory paradigm is emerging that: 1. Recognizes there will not be a single network. Rather there will be networks of networks. 2. Focuses on ensuring that these networks are open systems -- that they are open to use by customers and potential competitors on a common carrier [5] basis. Networks must interconnect smoothly. Communications between subscribers of different networks must occur transparently to the subscriber. 3. Opens all telecommunications markets to competition. The eventual goal should be to encourage full competition in all telecommunications markets. Commission regulation would shift from price and profit regulation, to regulation of interconnection arrangements, performance standards, and consumer protection. 4. Fairly allocates the costs of transition among subscribers who will receive more choices and providers who will receive new market and profit opportunities. 5. Encourages providers to remove services from regulation by eliminating their ability and incentive to subsidize competitive offerings with monopoly rates. Although the specific intent of the Notice is to focus on a successor U S West AFOR, the principles developed through comments and further analysis apply more broadly. This paper will explore developing trends in the technology and market structure of the telecommunications industry and attempt to define the basic policy objectives that we believe an AFOR should accomplish under the emerging paradigm. Finally, we will propose questions intended to identify specific alternative mechanisms for a new U S West AFOR. TECHNOLOGY Rapid technological advances continue to shape telecommunications market structure and regulatory policy agendas. The deployment of technology today will determine the relative cost and efficiency of communications services, the range of voice, data or video services available over the communications network, and the rate at which new competition and competitors are introduced into the communications marketplace. The consistent trend has been toward network and customer premises equipment that is faster, cheaper, smaller and better. Communications networks are increasingly digital. This allows voice, data and video signals to be transported simultaneously and is propelling the convergence of the video entertainment, computing and communications industries. The deployment of common channel signalling [6] and intelligent databases has enabled telecommunications network switches to operate as computers. The new intelligent networks are capable of making real-time routing decisions based on the status of the network. They can respond quickly to network problems and to changes in user demand, optimize network capacity and ensure greater system and service reliability. Signalling System No. 7, the international standard for common channel signalling, allows network control functions to be separated from network switching functions. This permits the network to select the most appropriate services and optimal routes and allows the introduction of new value-added services through incremental additions of software. According to the 1993 U. S. Industrial Outlook [7], about 70 percent of telecommunications switches nationwide are digital. The U.S. Department of Commerce predicts that by the year 2000 essentially all local telephone lines will be digitally switched. [8] Currently, about 80 percent of U S West's local telephone central offices in the state and roughly 50 percent of the company's access lines are digitally switched. [9] The majority of rural exchanges served by independent telephone companies within Washington employ digital switching. The digital revolution is being matched with a corresponding increase in bandwidth -- which means that users can move a lot more information more quickly over communications networks. [10] Fiber optic cable is rapidly replacing older trunking plant and is increasingly being used in new feeder plant [11] construction. However, conventional wisdom is that a full "fiber-to-the- subscriber" network appears to be on a more extended time-line; full deployment is not expected until about the year 2010. This is partly because new signal compression technologies allow increased use of the telephone companies' existing copper facilities and the cable TV companies' coaxial networks. U S West/Time-Warner, Bell Atlantic/TeleCommunications, Inc./Liberty Media and Pacific Bell have recently announced that they each intend to deploy "fiber-to-the-neighborhood" broadband networks by the 1995-1996 timeframe. This indicates, for now, fiber optic trunking coupled with coaxial distribution facilities may be the optimal network configuration. Technological advancements in wireline service have been matched on the non-wireline side. Improvements in cellular portability are evident in the development in both smaller handsets and seamless national cellular networks. Cellular systems are also converting to digital transmission, which will allow for advanced services and a reduction in frequency congestion in major markets. Cellular penetration is increasing as costs are declining, making cellular a possible competitor for traditional local exchange service. At the same time, the FCC has allocated spectrum for market tests of personal communication services (PCS). PCS is based on "micro cell" technology, which uses numerous, closely spaced transmitters to create a communications network. While some analysts predict eventual replacement of landline phones by PCS, it is more realistic to expect that wireline systems will continue to dominate basic services during any reasonable planning horizon. Wireless telecommunications technology will continue to be used predominantly for personal number calling (PNC) [12] and mobile communications. Traditional telephone companies are also turning to radio services to reach remote customers for voice grade service. These services may be used increasingly to serve new residential developments in fast growing areas without transmission limitations. It is unclear what the ultimate potential of this technology is in terms of transmission quality and data transmission capability. Satellite-based services are also expected to provide significant competition for land-based wireline and wireless video and telephony networks. Hughes Communications, Inc. has announced that it will launch its "DirecTV" direct broadcast satellite service (DBS) in 1994, offering 150 channels of video entertainment at a cost of approximately $700 per receiver. [13] Digital compression technology has greatly enhanced the cost effectiveness and capacity of satellite-delivered communications by expanding the number of available channels, allowing the use of smaller and cheaper dishes, and facilitating the broadcast of high-definition television (HDTV). Presently, there are five different corporate joint-ventures planning to spend a total of about $7 billion to build low and medium earth orbit satellite systems that will serve as global "cellular networks in the sky." [14] The most ambitious venture is Motorola's "Iridium" project that envisions 66 satellites circling the globe in polar orbits 420 miles out. Current major partners in Iridium include aerospace manufacturers such as Lockheed, Raytheon and Krunichev Enterprise (Russian rocket- maker); electronics firms including Sony, Mitsubishi, Mitsui and Kyocera; long-distance providers including Sprint and DDI; and a number of international post and telegraph (PTT) agencies. Iridium is projected to be operational by 1998. In short, trends in technology indicate that there will almost surely be multiple networks and transmission "paths" to the end user provided over wireline, radio and satellite-based systems. One estimate is that local exchange customers will ultimately have the option of receiving service from two to three wireline-based carriers and three to five wireless providers. [15] MARKET STRUCTURE More sophisticated technology and declining costs are being complemented by changes in consumer demand. Telecommunications subscribers are acting more like consumers with real choices and less like captives. Consumers have an expectation of enhanced service and customization. If not, they expect to be able to move to a competitor or to a private network. This is especially true with business customers, although it will be increasingly the case throughout the residential customer market. In the last decade, robust competition has developed in interstate long distance telephone service, data communications services, and customer premises equipment. There are now at least three competing national long distance carriers, each of which has deployed fiber optics and digital technologies throughout its network. Competition in intraLATA toll services for high-volume users is also intense, but has remained confined to the large user submarket due to the fact that local exchange companies continue to retain exclusive access to the "1+" presubscription capability. According to the 1993 Industrial Outlook, the data communications sector, which includes local area network (LAN) interconnection, wide-area networking, data processing and value- added network services (such as "CompuServe"), is growing by 20 percent per year. Traditional customer premise devices, such as telephone handsets, are now available from hundreds of manufacturers and their prices have fallen dramatically. There has also been an explosion in the diversity and functionality of equipment like modems and fax machines. The focus of competition in local markets has been on the growing number of competitive access providers (CAPs). CAPs generally provide special, dedicated access between large corporate end users and long distance companies over state-of- the-art fiber optic networks. Recent landmark decisions by the FCC and state PUCs in New York and Illinois, will enable CAPs and other alternative providers to place their equipment in the local telephone company's central offices, and thereby gain ubiquitous switched access to offer competitive services to local exchange subscribers. While there has been significant competitive entry and erosion of incumbents' market shares, demand for telecommunications services also appears to be rapidly expanding. According to FCC data, AT&T has lost nearly 40 percent of its market share of interstate long distance minutes since divestiture in 1984, yet growth in the amount of interstate toll minutes carried by the company has increased by approximately 68 percent. [16] Therefore, the communications business may not, in fact, be a zero-sum game as is sometimes alleged -- with "loss" of a customer's business amounting to a permanent reduction in revenues. [17] The convergence of technologies and providers, coupled with the explosion in bandwidth, will bring consumers new services such as digital video-on-demand, speech recognition, and telecomputer and multimedia services. These will be delivered by providers who no longer fit within the discrete "boxes" that today we call local exchange, cable TV, long distance, cellular, or information service providers. The major providers will act instead as full service communications/multi-media companies. Dr. Eli Noam, director of the Columbia University Institute of Tele-Information, has suggested in a recent article that a central institution of the emerging telecommunications environment will be "systems integrators" that offer consumers access to a variety of services on a "one-stop shopping" basis. The characteristic of "pure" systems integrators -- for there will be various hybrids -- is that they do not own or operate the various sub-production activities but merely sel/ect optimal price and performance elements, package them, manage the bundles, and offer them to the customer on a one-stop basis. Systems integrators are similar to general contractors in construction projects, travel packagers, or computer service firms. They relieve customers of the responsibility of integration for which expertise is required. To these customers, the identity of the underlying carriers and their technology might be unknown as transmission becomes a commodity. [18] A current example of a type of system integrator, operating in the data communications marketplace, would be the existing Internet [19] service providers that offer menu-driven access to the Internet combined with electronic mail and a variety of other information and software services. The success of the Internet model is indicated by the 15 percent monthly growth rate of subscribers over the past two years. [20] Changes in customer demand and multimedia technology have already led to a number of corporate joint-ventures and mergers that would have been difficult to predict just a few years ago. The March 1993 merger of Sprint and Centel was the first instance since the AT&T divestiture that local service, cellular and long distance services were combined under one company. The August 1993 joint-venture of AT&T and McCaw Cellular was designed to produce the first nationwide, seamless cellular communications network. The recent Bell Atlantic/TCI/Liberty Media and U S West/Time Warner megadeals confirm that telephone companies will be adding video service and competing with cable companies who will be providing voice service. Motorola, Scientific-Atlanta and Kaleida Labs (a joint- venture of Apple Computer and IBM) have announced their collaboration on a new kind of cable set-top box that will bring interactive media to American households. A similar effort is in progress through an alliance of Intel, Microsoft, and General Instrument. The ongoing bidding war between Viacom, Inc. and QVC Network, Inc. to acquire Paramount Communications demonstrates dramatically the considerable value that network operators perceive in the ability to provide consumers with an extensive library of entertainment "software." One industry newsletter, Digital Media, has noted nearly 350 alliances among communications, cable and computer industry players over the past 18 months. [21] REGULATORY POLICY Market Entry For traditional telecommunications local exchange companies to participate fully in the convergence of services and service providers, they will have to confront existing legal and regulatory barriers to their entry into the emerging multi-media marketplace. The primary barriers are the telco/cable cross- ownership prohibition of the Cable Communications Policy Act of 1984 and the interexchange line-of-business restriction of the Modified Final Judgment applicable to the Bell Operating Companies and their affiliates. The relevant provision of the Cable Act [22] may prohibit a local exchange carrier from providing video programming to subscribers within its telephone service area, either directly or through affiliates. The FCC has determined that this restriction is triggered when a local exchange carrier's ownership interest in a programming affiliate reaches or exceeds five percent. The Cable Act provides that the prohibition may be waived for "good cause." The other impediment to Bell Operating Company provision of converged, multi-media services is the interexchange service restriction in section II(D)(1) of the MFJ. [23] In addition to prohibiting Bell Operating Companies from providing interLATA and international long distance services, the interexchange restriction may prevent a Bell Company from operating satellite uplink or cross-LATA transport facilities necessary for the transmission of video entertainment services. Judge Greene recognized that relief from the interexchange restriction may be appropriate as the industry evolves and incorporated section VIII(C) of the MFJ to afford relief from the restriction: The restrictions imposed upon the separated Bell Operating Companies (BOCs) by virtue of Section II(D) shall be removed upon a showing by the petitioning BOC that there is no substantial possibility that it could use its monopoly power to impede competition in the market it seeks to enter. (Emphasis added) [24] Both the Cable Act's cross-ownership ban and the MFJ's interexchange restriction were enacted to check local carriers' monopoly power over the local access and transport network. With control of this vital physical link between customers and service providers, a local exchange company can allocate competitive advantages and disadvantages among providers through its access pricing and by dictating the technical details of the access service it provides. At the extreme, a local exchange company could keep independent service providers out of a market altogether by engaging in exclusionary pricing or by providing a quality of access that is so inferior technically that the independent supplier cannot provide service. Moreover, as long as the local company retains a bottleneck monopoly, it has the incentive and the means to subsidize its competitive lines of business. [25] While the FCC has recommended the repeal of the cable cross- ownership ban, Congress is considering other proposals that require a quid pro quo -- the elimination of line-of-business restrictions preceded by protections against the types of anticompetitive behavior noted above. [26] Other proposals for removing restrictions involve structural changes in local exchange carriers. Two companies, Rochester Telephone, a multi- state independent telephone company, and Ameritech, a Regional Bell Company, have recently proposed sweeping restructures in return for regulatory reform and the opportunity to recast themselves as the type of "systems integrators" envisioned by Dr. Noam. On February 3, 1993, the Rochester Telephone Company (RTC) of Rochester, New York, filed an "Open Market Plan" with the New York Public Service Commission. The company proposes to split its local service operations into two distinct companies. One, called "R-Net," would be fully regulated by the New York Commission. It would serve as a wholesale network company, providing basic dial tone and other network services to all local exchange competitors, who would resell the services to customers in the Rochester area. The second company called "R-Com," would be a competitive provider of retail communications services to the general public. Regulation of R-Com would be limited to basic exchange service pricing, with all other service offerings deregulated. R-Com would buy basic network features and functions from R-Net under the same rates, terms and conditions offered to all other local service competitors. Rochester proposes features that it contends will ensure R- Net's independence, avoid consumer "rate shock" and ensure that local exchange competition actually materializes. Those features include insulation of R-Net from influence by R-Com, rate stability plans for both R-Net's wholesale network service and R- Com's retail local services, and a customer selection choice or ballot process under which subscribers could choose their new provider(s) for local and intraLATA services. On March 1, 1993, "Customers First: Ameritech's Advanced Universal Access Plan" was filed with the FCC as a regional program for the states of Illinois, Indiana, Michigan, Ohio, and Wisconsin. "Customers First" proposes that in exchange for relief from the interexchange restriction of the MFJ and the cable television cross-ownership prohibition, Ameritech would: 1) agree to allow competitors to physically interconnect their loops and switches to the company's network; 2) provide competitors with their own blocks of telephone numbers and work with competitors to provide enhanced forms of number portability; 3) implement usage subscription under which customers may choose their local, intra and interLATA carriers; and, 4) offer local competitors exchange support functions such as billing and collection, operator services, directory assistance, 911 and directory listings on a contractual basis. While it is impossible to predict how the New York Commission will treat the Rochester petition, or the FCC the Ameritech proposal, these plans offer intriguing images of a regulatory framework that could promote the wider use of the public switched network infrastructure and the development of effective competition in local and intraLATA services. Although neither proposal may be appropriate for U S West, the concept of structural reform remains an attractive object of study. Transition to Competition The fact that the Clinton Administration, Congress, regulators and companies are now considering significant changes in the basic regulatory framework is not surprising. For over 40 years, regulatory conventions supporting a monopolistic and monolithic telecommunications industry structure have been consistently eroded by changing technology and market structure dynamics, and ultimately superseded with new federal and state policies favoring competitive entry and the development of effective competition. [27] As competition for services has increased, traditional regulatory methods have yielded to an increasing degree of regulatory flexibility and forbearance. The task has been a painstaking one of peeling back the layers of monopoly control while ensuring that embryonic competition can mature and thrive. The essential role of regulation has been to protect captive customers who need to purchase an essential service. A major challenge to this traditional regulatory paradigm emerged in the 1980s, as more companies became hybrids, providing both monopoly and competitive services. This has put regulators in the difficult position of ensuring that regulated companies do not leverage monopoly power to their benefit in competitive markets, ensuring that local exchange subscribers do not subsidize competitive ventures, and ensuring that regulation does not serve as an inappropriate brake on technological and social progress. The boundaries of state telecommunications regulation are also continually being called into question. The 1992 Federal Cable Act increased local government's role in the regulation of cable services at a time when the cable and telephone industries are merging. The result of that Act may be a collision between two regulatory regimes -- local cable regulation vs. state telephone regulation. Further, it appears there will be federally chartered technologies, such as cellular, which are not subject to significant state regulatory requirements. Federal initiatives are freeing cellular companies and personal communication service (PCS) providers to compete with incumbent local exchange companies. Under the recently adopted federal Budget Reconciliation Act, state regulation of cellular has been preempted for one year and regulation of PCS has been permanently preempted. [28] Although the trend is leading toward more balkanized regulation of services, we believe that regulatory strategies based on technologies (particularly with digital networks) and retail service categories will be more difficult to sustain in an age of rapid industry convergence. For its part in the transition, this Commission has used state legislative tools created in the Telecommunications Regulatory Flexibility Act of 1985 [29] to continue to "peel the onion," removing layers of regulation as companies and services become subject to effective competition. Effective competition under the act means that customers have reasonably available alternatives and the company does not have a significant captive customer base. The state's AFOR statute [30] has been applied by the Commission to U S West to achieve "incentive regulation" intended to stimulate productive efficiency and the sharing of productivity benefits with ratepayers -- perhaps the best results one could expect from any type of AFOR operating under a monopoly market construct. Policy Staff believes that, ultimately, effective competition will provide the most efficient and effective incentive regulation of U S West. Where competition has been introduced so far -- in the long distance marketplace, on-line information services, and customer premises and network equipment markets -- the results have been very encouraging. Consumers have benefitted from unprecedented diversity in supply and real price competition. Growth in new competitive communications services and service providers will be a critical element of the future economy of Washington. Moreover, we believe that competition will be the best means of accommodating the convergence of the communications, cable and computer industries, which also promises significant consumer benefits. In a converged marketplace, local telephone service will inevitably become simply one component of a multi-media service package. Given this trend, local telephony may eventually cease to be commercially viable as a stand-alone service. It is important, therefore, that regulators, service providers, users and other stakeholders come together now and work on defining the organizing principles for local exchange competition to flourish. In Policy Staff's view, a comprehensive policy for achieving this goal would include the following elements: 1) Open Systems -- With the convergence of cable and communications services, most consumers can now expect that at some time in the future, there will be at least two communication pathways to their home. Additional pathways can be expected from developing radio and satellite-based systems. While this emerging network competition should make a difference to consumers, the principles under which this competition will operate are of equal, if not greater, importance. Increasingly, the message from those like Dr. Noam, reinforced by the Ameritech and Rochester proposals, and demonstrated by the Internet, is that an open systems approach is a more effective and efficient strategy for generating and sustaining diversity, innovation and dynamic efficiency in a national information infrastructure. Open systems means that networks would be designed along principles of open access and diversity in both providers and applications. To the greatest extent possible, interface standards and technical details would be established and updated through a public process. The critical implication of open systems is that competition exists not only between network operators but also between providers of applications that are available over those networks. Nicholas Negroponte, Director of the MIT Media Lab, has expressed a concept for open systems in cable set-top box technology that we believe should also serve as the vision for open communications networks: Open systems exercise the entrepreneurial part of our economy and call into question proprietary systems and broadly mandated monopolies. In an open system we compete with our imagination, not with a lock and key. The result is not only a large number of successful companies, but a wide variety of choice for the consumer and an ever more nimble commercial sector, one that can change and grow. [31] An open system offers the opportunity for genuine "interactivity" where the network user is not only a consumer of video on demand and home shopping network products but also a "prosumer" creating information and images that can be sent over the network. Open systems hold forth the potential for relaxation of regulatory restrictions, but also, as Rochester Telephone and Ameritech have indicated in their proposals, there may a business case for promoting a wider use of local networks. Some of the essential policies needed to foster open systems include: * Elimination of all significant legal and regulatory barriers to the competitive supply of telecommunications delivery networks and retail services. [32] * Switched public networks that serve as "Open Network Platforms," based upon standards that promote reciprocal interconnection, well-defined interconnection points and interoperability with other public and private networks. * Common carriage access available to every "building block" [33] function of the local exchange network, whether or not the dominant carrier uses the functions in its own finished services, on an open, unbundled and nondiscriminatory basis. * Expanded numbering and expanded access to telephone numbers should evolve to support new providers and services in the competitive communications marketplace. * Appropriate safeguards, including corporate restructures, that address local exchange companies' natural incentives and abilities to confer competitive advantages on their own "retail" service operations. 2) Widely Available and Affordable Service -- The Commission has an obligation to maintain policies that ensure consumer access to a "provider of last resort" and universal affordable local telecommunications service. As the communication industry moves from a closed monopoly system to a more open competitive market, the question arises whether the existing system will continue to support service to high-cost areas and low-income subscribers. For rural companies to thrive, they may need to aggregate demand and use network facilities more efficiently. In addition, rural providers may need to be aggressive in providing more complete communications solutions for customers. In short, successful rural companies will likely require greater innovation than urban areas in order to maintain affordable network access. The challenge is to ensure that any future policies targeted to high cost areas do not also increase impediments to competition. This will require adaptation on the part of both the companies and the Commission. While competition can be expected to enhance innovation, efficiency and price competition, there may still be a need to ensure a basic level of access for all consumers, regardless of income. In general, the existing broad-based method of subsidizing affordable service should be fully transitioned to a program targeted to the end user rather than to the underlying provider. 3) Market-Driven Technology Deployment -- There is a tendency for the communications debate to dwell on specific technology deployments and network applications when talking of the future. And while such visions are essential to a dynamic marketplace, they can also be stifling if public policy is designed to guarantee their implementation. A policy that focuses on a specific technology or a set of applications is a policy destined to choke off competition and thus diminish innovation and dynamic efficiency. Network upgrades should be propelled to the extent practicable by market forces rather than governmental edict. 4) Freedom of Choice and Speech -- Consumers should have complete freedom to choose their communications providers. A consumer choice or ballot process should be implemented under which subscribers exercise their choice for local and intraLATA service providers. This process could be similar to the long distance carrier selection process that subscribers went through following the break-up of AT&T. As the number of networks increases, the amount of consumer information collected by various parts of the system will also increase. Privacy concerns have been raised in the context of services such as Caller ID, and they are likely to increase as new applications are developed and existing data resources become more widely accessible. While an open system requires relatively free information flows, consumers must retain control over collection, manipulation, and disclosure of sensitive personal information. As cited previously, Bell Atlantic recently won a lower court ruling that the 1984 Cable Act's cross ownership prohibition is unconstitutional on First Amendment grounds. U S West has recently filed a similar case. While it will be some time before the Courts resolve this free speech issue, policymakers should recognize the strong first amendment values inherent in the communications marketplace. Common carriage principles should encourage the broadest possible participation in the free exchange of ideas and information. In a global information economy, networks based on open systems that uphold users' rights to privacy and free cultural and political expression will confer a competitive advantage. 5) Focused Regulation -- Discipline of communications providers should transition away from pervasive government regulation to effective competition -- shifting attention away from corporate earnings and service pricing toward fair interconnection, common carriage and consumer protection. Yet, local exchange companies fear that under current law, regulation will not be relaxed until their competitive position is eroded, possibly to a fatal level. Reform proposals by Rochester and Ameritech, however, indicate a trend toward expanded interconnection and greater consumer choice in exchange for removing line-of-business restrictions and easing regulatory requirements. This trend raises the possibility that a telephone company could seek relief from regulatory requirements and restrictions if it adopts new policies that ensure an open network and protect against cross subsidization. The transition to competition also will challenge previously held assumptions about capital recovery and depreciation policies. Recovery of capital investment has been and should continue to be based on the actual useful life of the asset. The increased application of fiber and the perceived demand for its broadband capabilities are causing local exchange companies to demand faster recovery of embedded costs of copper facilities. As competition penetrates all telecommunications services, however, more rapid capital recovery may cause existing captive ratepayers to underwrite the incumbent's infrastructure for future forays into competitive broadband ventures -- posing an impediment to potential competitive entrants. A review of capital recovery and depreciation will need to be part of any new AFOR. The transition to effective competition in all telecommunications markets requires a focused regulatory framework which rewards the incumbent local provider for opening up its network, protects against cross-subsidy, ensures widely available and affordable service, and promotes consumer choice. INVITATION TO COMMENT Our recommendation to the Commission is to issue an invitation under the Notice for interested parties to comment on at least the following questions: 1. What should the successor AFOR for U S West look like? In particular, are changes in corporate structure needed to enhance competition, protect monopoly ratepayers, and allow market forces to guide technology deployment? 2. Will changes in current depreciation methods be needed in the context of increased competition and alternative forms of regulation? If so, can monopoly ratepayers be protected from subsidizing the competitive ventures of regulated firms? 3. What are the rules, laws, ratemaking policies and structural changes necessary to facilitate transition to an effectively competitive local exchange marketplace? How does a successor AFOR plan fit into this transition? 4. Can any of the regulatory mechanisms adopted in the aftermath of the AT&T divesture be appropriately used to facilitate competition in local exchange markets? What competitive benchmarks can be used to evaluate reduced regulation of local exchange companies? 5. How do we promote widely available and affordable telephone service in a competitive environment? 6. What consumer protection regulations does the Commission need to retain as competition develops? 7. Do the policy elements identified by Policy Staff's paper encompass the core issues the Commission should consider as it evaluates a successor to the US West AFOR? What other issues and concerns need addressing and what recommendations can be made to resolve them? ********************************************************* Endnotes: 1. A prior order in these consolidated proceedings was misnumbered. The order of September 3, 1993, inadvertently designated the Nineteenth Supplemental Order, should have been denominated the Twentieth Supplemental Order Modifying the Alternative Form of Regulation. 2. The history and details of the existing U S West AFOR are summarized in Appendix 1. 3. Exogenous cost changes are changes in cost structure over which company management exercises little or no control. 4. Letter from Dennis I. Okamoto, Vice-President, U S West Communications-Washington to Paul Curl, WUTC Secretary. 5. In the telecommunications context, a common carrier is a company, typically licensed by the state or federal government, that furnishes telecommunications services to the general public for a fee. A common carrier may not refuse to carry your messages as long as you conform to applicable rules of state or federal authorities. 6. Common Channel Signalling is a means of transmitting network management information over a circuit separate from the communication (voice or data) circuit. 7. United States Industrial Outlook, 1993, U.S. Department of Commerce, International Trade Administration, p. 28-5. 8. Id. 9. Most of the company's remaining analog stored program control switches are located in urban areas with higher concentrations of customer access lines. 10. The amount of bandwidth a transmission channel is capable of carrying tells you what kinds of communications can be carried on it. A broadband circuit, for example, can carry a TV channel. That same broadband circuit capable of providing one TV channel could also be used to carry approximately 1,200 simultaneous voice telephone calls. 11. Feeder plant includes the wires or cable that run from the telephone company's central office to the local distribution point where lines are "distributed" to the customer premises. 12. Personal number calling is the ability to attach telephone numbers to persons who subscribe to the communications service, rather than to the locations where the subscribers use their communications devices. 13. United States Industrial Outlook, 1993, p. 28-11. 14. Joe Flower, "Iridium," Wired magazine, Issue 1.5, November 1993, Wired USA LTD., San Francisco, CA. 15. Remarks of Richard McCormick, Chief Executive Officer, U S West, Inc., before the U S West Regional Oversight Committee,Semi-Annual Meeting, Denver, CO. March 15, 1993. 16. FCC, Industry Analysis Division, "Long Distance Market Shares," First Quarter 1993, issued June 1993. 17. Distinctions between "tariff bypass" and "facilities bypass" are also important. 18. Eli M. Noam, "From the Network of Networks to the System of Systems -- An End of History in Telecommunications Regulation?," Cato Review of Business and Government, 1993, No. 2, p. 26. 19. Internet is a computer network joining approximately two million government, university and commercial computers together over telephone lines. Internet originated from the Advanced Research Projects Agency of the U.S. Department of Defense and now links other networks, including the National Science Foundation Network (NSFNET) and hundreds of research centers and universities in the U.S. and in foreign countries. 20. John Markoff, "Traffic Jams Already on the Information Superhighway," New York Times, November 3, 1993, p. A1. 21. Amy Johns, "Alliance Fever: A Snapshot in Time," Digital Media, Volume 3, No.1, Seybold Publications, June 23, 1993, pgs. 13-18. 22. 47 USC, Section 533 (b)(1). The Federal District Court for the Eastern District of Virginia has declared this statute facially unconstitutional on First Amendment grounds. The Chesapeake and Potomac Telephone Company of Virginia v. United States, 830 F. Supp. 909 (E.D. Va. 1993). U S West is seeking similar relief in Federal District Court for the Western District of Washington in U S West, Inc., et al. v. United States, et al., No. C93-1523 (W.D. Wash.). 23. United States v. American Tel. and Tel. Co., 552 F.Supp. 131 (D.D.C. 1982) aff'd mem. sub nom., Maryland v. United States, 460 U.S. 1001 (1983). 24. From a lay perspective, a question may be raised as to whether the relevant market would be defined in terms of the "incremental" market the Regional Bell Company seeks to enter or whether the relevant market would be an expanded multimedia service base. 25. While the threat of antitrust enforcement may restrain anticompetitive behavior, pursuit of antitrust remedies often requires a substantial commitment of resources and can take many years to achieve meaningful results. 26. H.R. 3636 and S. 1086, introduced by Rep. Edward Markey and Senators Inouye and Danforth, respectively, would, among other things, require local phone companies, including the Regional Bell companies, to provide equal access to their networks before they could enter restricted markets. These proposals have taken on increased interest with the Clinton Administration's commitment to push for adoption of a new federal communications act in 1994. 27. See Appendix 2. 28. Washington State law also exempts radio communication services from Commission regulation. RCW 80.36.370 (6) 29. The policy objectives of the Regulatory Flexibility Act are to: (1) Preserve affordable universal telecommunications service; (2) Maintain and advance the efficiency and availability of telecommunications service; (3) Ensure that customers pay only reasonable charges for telecommunications service; (4) Ensure that rates for noncompetitive telecommunications services do not subsidize the competitive ventures of regulated telecommunications companies; (5) Promote diversity in the supply of telecommunications services and products in telecommunications markets throughout the state; (6) Permit flexible regulation of competitive telecommunications companies and services. RCW 80.36.300 30. RCW 80.36.135(2) directs the Commission to consider, in determining the appropriateness of any proposed AFOR, whether the proposal will: (a) Reduce regulatory delay and costs; (b) Encourage innovation in services; (c) Promote efficiency; (d) Facilitate the broad dissemination of technological improvements to all classes of ratepayers; (e) Enhance the ability of telecommunications companies to respond to competition; (f) Ensure that telecommunications companies do not have the opportunity to exercise substantial market power absent effective competition or effective regulatory constraints; and (g) Provide fair, just and reasonable rates for all ratepayers. 31. Nicholas Negroponte, "Set-Top Box As Electronic Toll Booth: Why We Need Open Architecture TV," Wired magazine, Issue 1.4, September/October 1993, Wired USA LTD., San Francisco, CA. 32. Ideally, this would apply to government policies for construction of public networks, franchise restrictions and access to rights-of-way that currently impede new competitive entrants. We recognize that this Commission does not have jurisdictional authority over this area. 33. A "building block" is considered the smallest, most discrete element of network functionality that could potentially be offered under tariff as a separate service. (See Oregon PUC Docket UM-351) ********************************************* APPENDIX 1 SUMMARY HISTORY AND DETAIL OF THE U S WEST ALTERNATIVE FORM OF REGULATION (AFOR) Notice of Inquiry/Open Letter The genesis of the existing U S West AFOR dates back to September 1987, when the Commission issued its first Notice of Inquiry on regulatory streamlining and incentive regulation in Docket No. 87-1320-SI. Through that inquiry, the Commission sought to explore whether meaningful regulatory incentives could be developed to improve the efficiency of telecommunications companies without sacrificing quality and affordability of service. The original Notice sought comment on regulatory stream- lining, rate of return incentives, and quality of service issues. During the fall and winter of 1987 the Commission took two rounds of comments on the notice of inquiry. Subsequently, Commission staff issued a report with recommendations. These recommenda- tions addressed a number of regulatory streamlining issues, but left rate of return incentives and service quality issues for further study. Oral comments were taken on the staff recommenda- tions. These comments offered general support for regulatory streamlining but also expressed a desire on the part of some companies to move ahead with a more comprehensive incentive regulation plan. The comments also revealed concerns on the part of consumer and business user representatives that any regulatory changes ensure that ratepayers pay only fair, just and reasonable rates for quality telecommunications services. Some Washington local exchange telecommunications companies expressed an interest in proposing specific incentive regulation agreements consistent with the Commission's goals. On October 7, 1988, the Commission issued an Open Letter to the industry inviting incentive regulation proposals that would comply with the objectives established in the notice of inquiry. To provide guidance to companies in drafting proposals, the letter set forth general guidelines that every plan must meet. The guidelines established were as follows: 1. Initial rates and any rate decreases for monopoly services over the term of the proposal should be specified. Rates for basic monopoly service should either be frozen or reduced to account for cost reductions. The proposal should also address how spare or unused capacity will be treated. 2. The plan should specify if the company is seeking banded rate treatment of any services not price listed under the Regulatory Flexibility Act. Petitions for detariffing under the Regulatory Flexibility Act are to be filed separately. 3. Implementation methods for rate of return flexibility proposals should be detailed. The company should also demonstrate that its rate of return flexibility provisions are equal to or an improvement over traditional rate of return standards. 4. The plan should specify the service quality standards that will be maintained. These standards should be objective and easily measurable. 5. The proposal should include explicit company plans to modernize plant over the term of the proposal, as well as specific plans and supporting cost data for: (a) conversion to universal single party, touch-calling service, and (b) to eliminate or reduce suburban mileage charges. 6. The proposal should specify a method for monitoring the effectiveness of the plan. 7. Guidelines for Commission review of new services should be proposed. 8. The plan should be for a term of three years with provisions for cancellation, renegotiation or renewal. The Commission recognized that different telecommunications companies may have different regulatory needs, depending upon factors such as their organizational and financial structures, capital and operating costs, markets, services, and geographical areas served. The Open Letter's guidelines were intended to be flexible. The ultimate criterion the Commission would use in judging any proposal would be whether it would serve the public interest and generate real benefits for consumers. Chapter 101, Laws of 1989 The 1989 legislature adopted Chapter 101, Laws of 1989 (codified as RCW 80.36.135) authorizing the Commission to employ alternative forms of regulation of telecommunications companies. The statute incorporates a finding that based upon changes in technology and structure of industry, rate of return regulation may not be the most efficient and effective means of achieving the state's telecommunications policy goals. [1] Pursuant to RCW 80.36 135 (3), the Commission may, upon petition by a party, or upon its own motion, approve an AFOR plan if the Commission finds, after notice and hearing, that such an alternative is: (a) Is in the public interest; (b) Is necessary to respond to such changes in technology and the structure of intrastate telecommunications industry as are in fact occurring; (c) Is better suited to achieving the policy goals set forth in RCW 80.36.300 and this section than the traditional rate of return, rate base regulation; (d) Ensures that ratepayers will benefit from any efficiency gains and cost savings arising out of the regulatory change and will afford ratepayers the opportunity to benefit from improvements in productivity due to technological change; (e) Will not result in a degradation of the quality or availability of efficient telecommunications services; (f) Will produce fair, just and reasonable rates for telecommunications services; and, (g) Will not unduly or unreasonably prejudice or disadvantage any particular customer class. Earnings Complaint/Settlement Agreement On February 21, 1989, in Docket No. U-89-2698-F, the Commission issued a complaint against U S West for the purpose of investigating the propriety of the rates and charges applicable to the company's services. On September 26, 1989, parties to that proceeding submitted to the Commission a proposed settlement of all disputed issues of the complaint and a stipulation to an alternative form of regulation. The principal provisions of the settlement agreement reached between Commission Staff, Public Counsel and U S West included : * Accepting a Staff recommended rate of return and revenue requirement, including a $65 million rate reduction, and resulting in the: - collapsing of exchange rate groups; - redefinition of complex business lines; - elimination of mileage charges; - elimination of existing EAS rate additives; - cappping of charges for enhanced 911 service; - reduction in carrier switched access charges; - elimination of touch-tone charges; - modification of toll timing method -- from one minute increments to six second increments; and * Supporting a petition by U S West for an alternative form of regulation. U S West AFOR Plan On October 4, 1989, in Docket No. U-89-3245-P, U S West petitioned for approval of the alternative form of regulation. The Commission consolidated the Commission complaint and AFOR petition proceedings for hearing on October 27, 1989. On January 16, 1990, the Commission approved the settlement agreement, with modifications, and granted the company's petition for an AFOR. The main elements of the AFOR plan adopted by the Commission included: * A five year term: January 1, 1990 -- December 31, 1994 * Setting of a range rate of return: 9.25% -- 11.00% * Capping Residence, Business and CCLC for term of the plan. * Permitting limited rate increases if company's earnings fall below 9.25%. * Permitting revenue neutral filings and miscellaneous increases, limited to a total of $950,000 annually, for price list changes, Universal Service Fund increments, Lifeline additives, municipal taxes, and rate changes within an approved banded tariff. * No automatic rate banding or detariffing. * Sharing of Excess Revenue with ratepayers for earnings above the 11.0% overall rate of return threshold as follows: - 11.00% -- 11.625% Ratepayers 60% U S West 40% - 11.625% -- 12.25% Ratepayers 50% U S West 50% - 12.25% -- above Ratepayers 40% U S West 60% - 100% of excess earnings above 11.00% go to ratepayers if due to tax, accounting or separations changes. * Distribution of the ratepayers' share among a set of specified alternatives: 1) rate restructures; 2) plant or service upgrades; 3) increasing the depreciation reserve; and, 4) negative surcharges (one-time credits). * Requirement of universal one-party service availability throughout U S West exchanges by December 31, 1994. * Settlement of U S West Direct litigation, including the annual imputation of approximately $66 million in U S West Direct revenue. * The filing by the company of monthly service quality reports on central office performance, held orders, service outages, trouble reports per 100 access lines. Annual customer surveys also required. * Directives to the Commission Staff to devise new service quality rules, and to U S West to comply with any new rules. * A prohibition on mandatory measured service proposed during the term of plan. * Policies and procedures for monitoring and review of the plan: * Commission option to review the plan in its third year. * Earnings reports to be filed are specified. * Commission accounting adjustments are identified. * Full ability for auditing and supplementary reporting. * Disputes to be considered in adjudicative proceedings. * Commission may initiate proceeding to reexamine or rescind the plan at any time. Telecommunications Service Quality Rules On February 26, 1993, the Commission adopted rules governing telecommunications service quality. The primary provisions of the rules included: * Installation of primary exchange access lines: - 90% of applications for installation of up to five residence or business lines shall be completed within five business days. - 99% of all applications completed within ninety days. * Local exchanges companies must ensure operator-assisted calls are accurately recorded; confidentiality is protected; emergency calls are properly routed; consumers can readily access live operator. * Local exchange companies must maintain business offices/customer centers, accessible by toll-free calling or in person. Criteria were set for maintaining payment agencies for urgent payments. * Setting local exchange company network performance standards for central office functions, interoffice facilities, outside plant, special circuits and digital private line circuits. * Requirement that all telecommunications companies establish procedures to minimize the effects of major outages. A major outage is defined as service failure lasting 30 or more minutes, causing disruption of local exchange or toll services to 1,000 subscribers, or causes total loss of service to a governmental emergency response agency. All companies are required to maintain and provide upon request plans for emergency operation during major outage; notify Commission of major outages; report on recovery efforts. * Instituting local exchange company network maintenance requirements and trouble report thresholds. * Setting standards for identification, monitoring, maintenance and protection of dedicated 9-1-1 emergency circuits. * Establishing requirements for filing of service quality performance reports by local exchange companies. Reporting required for central office performance, installation appointments met, primary held orders, upgrade orders held, and trouble reports. Sharing of Excess Revenues In each of the first three years of operation of the AFOR, U S West has earned sufficient income to trigger the "sharing" provisions of the plan. Figure 1 provides the total of annual excess revenues generated in each of the first three years under the AFOR, and details the company's and ratepayers' share. Figure 1 Total Ratepayers' U S West Year Excess Revenues Share Share 1990 $44,109,000 $21,680,000 $22,429,000 1991 $60,436,000 $28,657,727 $31,778,273 1992 $72,129,168 $33,347,870 $38,781,298 TOTALS $176,674,168 $83,685,597 $92,988,571 After considering the extensive comments of parties filed in each of the first three sharing proceedings conducted under the AFOR, the Commission distributed the ratepayers' share as described in Figure 2. Figure 2 1990 $14.88 million -- Negative surcharges (Applied to Residence/ Business lines and the carrier common line charge (CCLC) 5.00 million -- Depreciation Reserve Increase (Applied to Analog Switch accounts) 1.80 million -- E-911 Service Improvements --------------- $21.68 million 1991 $19.105 million-- Negative surcharges (Applied to Residence/ Business lines and the CCLC 9.55 million-- Depreciation Reserve Increase --------------- (Applied to Analog Switch accounts) $28.658 million 1992 $24.10 million-- Compression of Rate Groups and Restructure of Business rates 7.20 million-- Restructure of Toll rates 2.00 million-- Restructure of "800" service access ----------------- charges $33.30 million AFOR "Open Window" Review The U S West AFOR provided that on or after July 1, 1992, and before August 31, 1992, the Commission on its own motion could undertake to determine whether the public interest justified modification or termination of the AFOR. The Commission notified U S West and interested parties in an April 23, 1992 letter that it would exercise its option under the AFOR and institute a proceeding to review the existing AFOR ("the window review"). The Commission formally initiated the window review in its Fourteenth Supplemental Order issued August 25, 1992. As provided in RCW 80.36.135(6), the ultimate issue for Commission determination in the window review proceeding was whether the AFOR continued to satisfy the conditions set forth in RCW 80.36.135(3)(a)-(g). The Commission's August 25, 1992 Notice of Hearing set an October 16, 1992 deadline for the parties to prefile written comments on the statutory conditions and other relevant issues. A prehearing conference was held on November 10, 1992. In the prehearing conference, the Commissioners identified several major policy areas which should be addressed by the parties in contemplating modifications to the U S West. These policy issues were provided to the parties in the form of a bench request. The parties filed written responses to the Commission's Bench Request No.1 on December 14, 1992. A January 13, 1993 letter offered the Commission's perspective on the parties' responses to the Bench Request. The Commission encouraged all parties to participate in a series of meetings in an attempt to narrow the issues, and the range of positions on those policy issues identified in the Commission's letter. The Commission called for written reply comments from the parties which were filed February 19, 1993. The Commission entered an initial order on May 4, 1993, proposing modification of the current AFOR. The Commission received petitions for administrative review on May 24, 1993, from U S WEST, Commission Staff, Department of Defense/Federal Executive Agencies and Washington Independent Telephone Association (WITA), and answers to those petitions on June 3, 1993, from Commission Staff, MCI, and Telecommunications Ratepayers' Association for Cost-Based and Equitable Rates (TRACER). On June 8, 1993, the Commission issued a second Notice of Hearing in the window review proceeding and scheduled an evidentiary hearing for July 1, 1993. The hearing was conducted for the purpose of cross-examination of the testimony and exhibits of the parties addressing the conditions set forth in RCW 80.36.135 (3)(a)-(g). After evaluating the comments, testimony, and other evidence submitted by the parties, the Commission issued its Twentieth Supplemental Order on September 3, 1993. The order required the following modifications to the U S West AFOR in order that it may continue in effect until its scheduled termination on December 31, 1994. 1. The sharing mechanism for the 1993 and 1994 sharing years would be revised such that 80% of excess revenue between 10.53% and 11.00%, after the Commission has determined proper adjustments, would be returned to ratepayers. The remaining sharing bands would be adjusted so that 65% of excess revenue in the 11.00% to 11.625% band would go to ratepayers, and 35% would go to the company. In the band between 11.625% to 12.25%, excess revenue would continue to be distributed in equal 50% shares to ratepayers and the company. In the upper band, above 12.25%, the sharing percentages would be modified to return 65% of excess revenue to the company and 35% to ratepayers. 2. In conjunction with the annual earnings review under the AFOR, U S WEST would be required to demonstrate that it has satisfactorily complied with the Commission's telecommunications service quality rules. 3. The AFOR would be clarified to provide that the plan allows the Commission to refund the ratepayers' share of excess revenue through rate restructures that include permanent changes in rate design and permanent price reductions. 4. Accrual of interest at the customer deposit rate on the ratepayers' share of excess revenue would be required from the conclusion of each plan year until such funds are actually distributed. 5. Exogenous cost changes would not be limited to net decreases in tax, accounting, and separations costs as previously specified, but expanded to include cost reductions attributable to access charge decreases adopted by the independent local exchange companies. Recognition would be given to any revenue requirement changes to U S WEST resulting from a Commission ordered change in U S WEST's designated role as primary toll carrier for all local exchange company intraLATA toll and private line service. Exogenous cost reductions that result in continuing savings are to be included as a prescribed annual adjustment in subsequent years and passed through to ratepayers at 100%, unless disposed of through permanent rate reductions. The Commission required that all of the modifications must be accepted by the company within 60 days of the entry of the Twentieth Supplemental Order. In addition to ordering modifications, the Commission directed its Policy and Planning Section to prepare a Notice of Inquiry for the purpose of examining issues relating to a successor to the U S West AFOR. The Commission required that the Notice be issued not later than December 1, 1993. By letter dated October 29, 1993, U S West accepted the AFOR plan as modified. ************************************** Endnotes to Appendix 1: 1. As detailed in the Notice, these policies are specified in RCW 80.36.300, RCW 80.36.135 (2)(a) through (g) and 80.36.135 (3)(a) through (g), and RCW 80.36.145. ************************************** APPENDIX 2 UNBUNDLING THE TELECOMMUNICATIONS "MONOLITH" -- AT&T CHARTERED TO PROVIDE END-TO-END SERVICES IN ALL MARKETS (EXCEPT INDEPENDENT COMPANY SERVICE AREAS) (1885) -- KINGSBURY COMMITMENT (1913) o Western Union Divested o Interconnection with/Toll Access for Independent Companies -- 1949 ANTITRUST SUIT (1956 CONSENT DECREE) o Attempt at Equipment Competition o AT&T Confined to Basic Services -- "HUSH-A-PHONE" (1955) o Attachment of Non-Detrimental Equipment to Network -- "ABOVE 890" (1959) o Private Microwave Networks -- "CARTERFONE" (1968) o Attachment of Customer-Owned Equipment to Network -- COMPUTER I (1971) o Deregulated Data Processing -- SPECIALIZED COMMON CARRIER DECISION (1971) o Competitive Private Line Services -- EXECUNET II (1978) o MTS/WATS Competition -- COMPUTER II (1980) o Detariffed Customer Premises Equipment o Structural Separation for Enhanced Services -- AT&T CONSENT DECREE (1982) -- COMPLEX INSIDE WIRE DETARIFFED (1982) -- CELLULAR TELEPHONE INDUSTRY SANCTIONED BY FCC (1983) -- AT&T DIVESTITURE (1984) -- COMPUTER III (1985) o Integrated Enhanced Services -- FCC DECLARES EQUAL ACCESS COMPLETED (1986) -- SIMPLE INSIDE WIRE DETARIFFED (1987) -- BILLING AND COLLECTION DETARIFFED (1987) -- NATIONAL RESEARCH AND EDUCATION NETWORK (NREN)/INTERNET (1990) -- COMPETITIVE ACCESS PROVIDER (CAP) INDUSTRY IS BORN (1990) -- NEW YORK PSC UNBUNDLING APPROACH -- COLOCATION AND CENTREX PRIVATE LINE RESALE (1991) -- FCC ORDERS COLOCATION/VIRTUAL COLOCATION FOR COMPETITIVE ACCESS PROVIDERS (1991) -- FCC INITIATES NOTICE OF INQUIRY ON SWITCHED COLOCATION/VIRTUAL COLOCATION FOR COMPETITIVE ACCESS PROVIDERS (1991) -- FCC APPROVES "FLEET CALL" SPECIALIZED MOBILE RADIO PETITION (1991) -- FCC ISSUES POLICY STATEMENT SUPPORTING LEC PROVISION OF "VIDEO DIAL-TONE" (1991) -- FCC DESIGNATES SPECTRUM FOR PERSONAL COMMUNICATIONS SYSTEMS (PCS) (1992) -- FCC ALLOWS ENTRY OF LOCAL EXCHANGE COMPANIES INTO VIDEO DIAL-TONE MARKETPLACE (1992) -- FCC REQUIRES LOCAL EXCHANGE COMPANIES TO OFFER "EXPANDED INTERCONNECTION" FOR ALTERNATIVE SPECIAL ACCESS PROVIDERS -- PROPOSED TO EXTEND TO SWITCHED ACCESS ARRANGEMENTS (1992) -- ILLINOIS COMMERCE COMMISSION ORDERS COLOCATION AND CENTREX/PRIVATE LINE RESALE (1992) -- FCC REQUIRES EXPANDED INTERCONNECTION FOR SWITCHED ACCESS (1993)