NRRI on Tenn ISDN Cost Study

The following paper by John Borrows and William Pollard was published in the National Regulatory Research Institute's NRRI Quarterly Bulletin, Vol. 15, No. 1, pages 125-139.

The National Regulatory Research Institute's Review of

Tennessee's Integrated Services Digital Network Cost Studies


John D. Borrows, PE

William Pollard

The National Regulatory Research Institute [1]

Introduction: In the Spring of 1993, The National Regulatory Research Institute was asked by the Tennessee Public Service Commission (TPSC) to evaluate two cost studies for basic rate integrated services digital network (ISDN) services and rate proposals. The following paper is the outcome of that effort. The results of this report were presented to the TPSC and Senior Staff members at the Commission's retreat at Paris Landing State Park, Tennessee on August 24, 1993.

Critique of Cost Studies: The purpose of this critique is to present the results of a review of two cost studies submitted to the TPSC in support of ratemaking for basic rate ISDN services to residential and small business customers. One study, submitted by South Central Bell Telephone Company (SCB), estimates the stand-alone cost of 2B+D service to be $66.13 for residential customers and $73.89 for small business customers. SCB estimates an additional $7.52 for right-to-use fees, operational support, and marketing expense per line. The TPSC Staff submitted a cost study that estimates the marginal cost of adding 2B+D service to a plain old telephone service (POTS) line to be $9.77 for residential customers and $10.99 for small business customers. This latter estimate includes allowances for right-to-use fees, operational support, and marketing. Not surprisingly, these disparities are based partly on the underlying philosophy and assumptions of the different cost-study methods. For instance, a comparable figure from the SCB study using the TPSC Staff assumptions is $36.33 for residential customers. This is SCB's estimated incremental cost of adding 2B+D service over and above an existing POTS line for residential customers. Obviously, the difference is not inconsequential and needs careful analysis.

In general, the SCB study may be characterized as a long-run study, while the TPSC Staff study is a short-run approach. However, there are several twists to this characterization that require considerable qualification. First, the two studies use differing costs of money and depreciation schedules. The SCB study assumes the cost of money is 13.34 percent; the TPSC study assumes the cost of money to be 10.42 percent.

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The TPSC study assumes the depreciation rate for digital central office equipment as appropriate for all investments and the SCB study uses depreciation rate specific to each plant and equipment account code. Neither of these two differences is discussed in this report. Second, the TPSC Staff study corrects loop costs for intrastate factors for access costs. Whether or not this is a costing issue or a cost-recovery issue bears directly on costing philosophy. The authors' position is that it is a cost-recovery issue, but results can be misleading when translating a cost study into rates if relevant toll rate considerations are not made explicit in the cost study in some manner. The remaining qualifications to the above characterizations of the two studies are deeply rooted in the choice of method.

The SCB study is a fairly standard Bellcore approach to estimating the long-run incremental cost of any service. This method is largely applicable to circumstances in which the Company is adding a new suburb or office park to its local-distribution network. The comprehensive nature and most visible consequences of the SCB approach can be seen in its inclusion of practically every nut and bolt of the loop plant, buildings and land. The authors' approach in evaluating the studies is to identify cost causation resulting from providing digital connectivity to customers and assigning these costs to the cost causers. Clearly, many of the cost elements included in the SCB study are not marginal (or additional) to providing ISDN services. A suburb or office park is not being added. There is a need for careful rethinking of the cost-study approach by people designing these studies.

The TPSC Staff study addresses this issue partially and also recognizes the potential impact of the FYI Tennessee Plan (Plan). First, the TPSC Staff study does not consider loop plant as marginal to the introduction of basic rate ISDN services. Consequently, costs of loop plant, except for pair-gain equipment, are excluded. Second, the investment factors related to land and buildings and administrative costs are excluded. The Plan's impact on the study is in the treatment of switch costs and interoffice trunk-plant costs. Implicit in the TPSC Staff approach is the assumption that sufficient digital investment exists in the switch and trunk plant categories as the result of the Plan. The TPSC Staff estimated the added costs to exhaust an existing digital office by changing customers from POTS to ISDN services. This approach to central office and trunk costs has merit given the Plan and investments undertaken over the past three years.

As noted, the TPSC Staff study only partially addresses the issues inherent in cost studies quantifying the transition from analog connectivity to digital connectivity. The SCB study has a cost factor of maintenance of new investment. Maintenance costs enter the study as roughly four cents for every dollar of investment. If a hundred dollars is spent on digital equipment, an additional four dollars of costs is assumed to occur for maintaining the investment. However, as explained in the next paragraph, careful rethinking of this procedure suggests such a factor is inappropriate for investments needed to change from analog to digital connectivity.

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The logic of this maintenance-cost factor assumes that additional investment requires additional floor space and equipment. This assumption in cost studies in general is based on a turn-of-the-century conception of manufacturing. Within that environment, added capacity meant both additional floor space and equipment. The added physical dimension requires increased labor to maintain the space and equipment. In a digital environment, such an assumption is inappropriate. With digital technology, Company personnel are replacing an integrated circuit board with another. Neither physical space nor the absolute amount of physical equipment is changing. Instead, the mode of electronic transmission is changing. There is no additional physical space or increase in the number of physical units of capacity. Consequently, the authors believe that estimates of maintenance costs should be excluded from both studies.

Another area in which the two cost studies differ is the treatment of administrative costs. Administrative costs are included in the SCB study as factors per dollar of investment. The TPSC Staff study excludes them. The authors posit that these costs should be excluded because of the down-sizing efforts within BellSouth's and SCB's organizational structure and because these expenses are common to all services. This down-sizing behavior on the part of Company decisionmakers suggests the pursuit of cost reductions in middle management and consequent productivity increases. This has been referred to as "right-sizing" within the Company confines. Given this behavioral attitude in the administrative area, one cannot reasonably assume administrative expenses are marginal (or additional) over the next decade. Whether or not the Commission should reward these cost-reduction efforts is not a cost issue but a pricing issue.

Even without these down-sizing efforts, the inclusion of administrative costs is questionable. The administrative effort involved with a new service is mostly at the front end. This effort emphasizes designing and implementing procedures to be followed in establishing the service and connecting customers. Once the procedures are established, administrative attention is directed elsewhere. A keen-eyed observer would be hard pressed to detect any long-run increase in administrative resources from establishing ISDN service. Instead, the cost is common to all services and not marginal to any particular service. Finally, basing administrative costs on dollars of investment suggests again the turn-of-the-century, cost-accounting logic discussed above.

Other additional considerations entering the cost equation for ISDN basic rate services involve subtle changes that have been going on in the distribution network that are largely unrelated to POTS and unrelated to the Plan. The changes are in the loop plant and relate directly to digital and video services. BellSouth has shifted from a resistance-design standard for feeder and distribution plant to a carrier-system concept. These upgrades have occurred under existing POTS rates. The cost studies presented by both SCB and TPSC Staff reflect these changes in design standards for the loop. The role played by digital line carrier and kilofoot standards in the cost study for digital

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connectivity are direct evidence of this investment strategy. However, the POTS studies submitted also reflect these changes in standards.

The SCB study is particularly perplexing in this regard. At the request of the authors, the Company submitted a ISDN and POTS long-run incremental cost study for analysis. The POTS study of loop plant differed from the ISDN study with regard to the assumptions for digital line carrier deployment and the percent of integrated deployment versus nonintegrated deployment. The deployment figures used in the studies reflect forecasts provided by network engineering to cost study personnel. In the two studies, this discontinuity in assumptions regarding deployment of digital line carrier raises two questions. First, how comparable are the two studies? Second, how might POTS costs change if digital line carrier assumptions did not reflect the joint provisioning of POTS and ISDN? Given the timeframe and the information available to the authors, these questions are not answered in this review but only raised as concerns.

The change in feeder and distribution standards may correctly be assigned to digital services and not to POTS. This is clearly a judgment call in cost studies. However, the issue is directly germane to the 30 percent of loaded loops currently in the network. SCB has verbally stated, a number of times that loaded loops need to be deloaded to provide ISDN services. At the authors' request, SCB provided an estimate of $1,942.72 to deload a typical loop over eighteen kilofeet. The estimate is based on a back-of-the-envelope calculation using averages and investment compositions (i.e. percentage investment in aerial, underground, and buried cable). These costs would seem directly attributable to digital services. If digital carrier systems were fully deployed, these costs may not be needed to achieve digital connectivity. Neither the SCB nor the TPSC Staff studies addresses the issue of deloading loops. Exactly how these costs enter a cost study is troublesome. Are they viewed as a nonrecurring expense for customer hook-up or are they capitalized as a capital improvement and amortized? Generally accepted accounting principles would probably support the first alternative, but the questions raised here need the attention of an accounting expert. Alternatively, one could assume the costs of deloading loops is captured in the change in design standards already underway and this 30 percent is the next increment for a change in standards. This lack of treatment by either SCB or TPSC Staff suggests such deloading loops may be business as usual and not marginal to ISDN. The authors' cost estimate does not directly address these costs but assumes these costs to be business as usual.

In the SCB study, advertising expenses appear to be treated as an after-thought and do not reflect an integrated marketing approach to basic ISDN services. The demand for basic ISDN is a derived demand; subscription to digital connectivity is based on the desire for services it can provide. The subscriber's cost equation has three basic elements: the cost of digital connectivity, the costs of digital customer premises equipment (CPE), and the subscription fee to applications that exploit digital connectivity. Initial subscription will come from customers one can characterize as

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innovators. Widespread adoption and success, however, depends on imitators and the services and conveniences available over digital connectivity. An obvious example of applications is the complexity that security systems can acquire. On a mass scale, transaction processing of a scope barely imaginable today may drive imitators to digital connectivity. This latter vision requires imaginative marketing policies to create an environment rich with incentives for the development of innovative applications and technical advancements in CPE. Part of this effort requires a reassessment of the vision embodied in the Plan. This vision is implicitly long run. The rate set for Basic ISDN Services could directly affect accessibility of digital service to residential and small business customers. Incentive structures in rates provide strong price signals to developers of applications and CPE. The focus of the incentives is not on SCB but on application and CPE providers. Emphasis should be placed on applications and CPE capabilities and costs. The marketing expenses in the SCB study need more analysis; however, it is beyond the scope of the authors' ability to quantify them. In essence, the issue is that marketing expenses for basic rate ISDN service are what the Commission forged as an agreement for the marketing of ISDN. Consequently, the marketing expense is excluded from the authors' estimate and is treated as a range.

Product-life cycle analysis of goods and services suggests future potential reductions in the costs of network equipment to provide digital connectivity and digital CPE. These cost reductions are a theoretical implication of the exploitation of economies of scale and scope in the manufacture of digital equipment as digital connectivity increases its market penetration. The question raised is the extent to which current cost studies and subsequent pricing should reflect these potential cost reductions. The TPSC Staff study contains an adjustment for future potential cost reductions in the digital line carrier cards used in the loop. The SCB study does not contain any such adjustment. Such adjustments to reflect potential cost reductions are based on the experience in integrated circuit boards which support such adjustments. Their inclusion in costs studies are judgmental but not necessarily incorrect.

Estimate of the Costs for ISDN Basic Rate Service: The authors estimated the monthly stand-alone costs of providing ISDN basic rate services (2B+D) to be between twenty-five and thirty dollars. This estimate is based on making the adjustments suggested above to the SCB cost study. Specifically, investment amounts included were taken from the SCB study as accurate costs of plant and equipment. The changes made were to exclude investment costs not deemed marginal to ISDN and to exclude factor adjustments for maintenance and administrative expenses. Marketing expenses are not included but are assumed to be negotiable and should fit within the range reported above.

Table 1 reports the authors' cost computations for residential customers in a format similar to the one included in the SCB study. The total cost for residential flat rate is $29.04 ($3.11 + .76 + 5.43 + 18.81 + .94). However, adjustments are not made for the

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Cost Element
Termination ISDN 2B + D $3.11
B Channels - 2B; CSV/CSD Flat Rate .76
D Channel - Low Speed Packet 5.43
ISDN Loop - 2B + D* 18.81
Software per TPSC estimate .94
* Loop costs are for pair gain card in digital line carrier equipment only.

82.30 percent intrastate toll factor used by the Staff. When this adjustment is made, the cost is approximately $24.00. The incremental cost for business customers differs only in the assumed higher usage of ISDN than residential usage. The row for 2 B Channels is $1.27 for business customers and suggest a total cost of $29.55 ($29.04 - .76 + 1.27). With the intrastate factor included, the business rate computes to approximately $24.50.

Tariffs: In addition to the information contained in the cost studies, the development of the rates, terms and conditions of service offerings must include consideration of policies and practices appropriate to the environment in which the services are offered. ISDN is a new access arrangement. It will compete with POTS offerings. ISDN is an important advancement in telephony that promises to improve the competitiveness of Tennessee businesses and provide valuable new capabilities to individual customers.

Preservation of Residential Preference: Arguments are frequently advanced that the costs of providing residential services are not different from the costs of providing similar business services, and thus the rates should not be different. Without reiterating the pros and cons of this debate, the authors observe that rate preferences have existed throughout the history of utility ratemaking. The authors recommend that the preferences that exist for POTS services be maintained for ISDN services. The preferences exist in rate levels, as well as terms and conditions of services. To the extent that POTS programs exist to assist residential customers based upon economic circumstance, physical impairment or other criteria, those programs should be extended to residential ISDN.

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Further, additional preferences should be considered particularly during the initial stages of ISDN deployment. Residential customers do not generally have access to the type of technical expertise that business customers have. The Company should aggressively address this information issue by creating information programs targeted at the residential market. The programs should recognize the diversity among residential customers and specifically target unique subgroups to assure that the benefits unique to the subgroups are effectively communicated.

Another area of consideration of preference is the cost of initial customer implementation of ISDN. A profitable business can write-off the costs of implementation for tax purposes. This tax savings is not available to residential customers. When ISDN initiation costs require financing by customers, the business customer uses established business financing capabilities. Residential customers may not have convenient, affordable, access to the financing of implementation costs. The Company could provide a valuable service to residential customers by financing some or all of the initiation costs, possibly at the Company's incremental cost of capital which is probably far below the cost of money faced by the residential customers, or often at a lesser cost in order to build the customer base. At a minimum, deferred payments of installation charges should be part of the Company's residential ISDN offering.

Preservation of existing pricing preferences in the basic recurring charges for ISDN can be implemented by identifying the difference in charges for basic POTS service for business and residential customers. That differential can be maintained between charges for the basic ISDN service used by business and residential customers. The existing difference can be expressed either as an absolute value or as a percentage of the business rate, and either the dollar value or the percentage of preference could be maintained. Maintaining the dollar value would be more "incentive neutral" for the Company because the Company would not perceive an increase in subsidy when a customer chooses to move from POTS to ISDN. For this reason the authors recommend that the recurring rate preference be maintained on a dollar basis, although the authors do not have major objections to the use of a percentage basis.

As a final test to the maintenance of the existing residential preference, the authors recommend that residential customer choosing ISDN should not lose any preferential advantage available with POTS service.

Comparison with Other Tariffs: The authors were furnished a preliminary draft of the South Central single-line ISDN tariff without prices. The authors compared that tariff with the single-line tariffs of Ameritech, NYNEX, U S West and a proposed Bell Atlantic (D.C.) tariff. Other Bell Operating Companies do not have single-line ISDN tariffs in effect.

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The authors concluded that the tariff structure proposed by South Central is reasonable. NYNEX treats ISDN as an optional feature to access, as opposed to a different access arrangement. Although NYNEX's approach appears to more perfectly reflect the concepts of open network architecture in that access is tariffed uniformly regardless of the character of the allowed transmission, the authors could not identify any substantive difference in the tariff arrangements. The authors do not recommend any change in the proposed treatment of ISDN as an alternative access arrangement.

Under the proposed tariff the customer can select activation of the D channel and activation of one or two B channels. Allowing the customer to select the configuration is appropriate. However, since customer selection of configuration means that there is not one single capability for an ISDN line, comparisons of POTS service with ISDN requires the specification of comparison ISDN line capability. The authors recommend such comparisons be based on a 2B+D ISDN line, with one B channel preselected voice and the other B channel per call voice or circuit data. This configuration includes each of the primary capabilities of the ISDN line and may be typical of the choice made by ISDN single-line customers. The authors would not include any of the ISDN vertical services for comparison purposes.

South Central and each of the other Company's tariffs apply usage charges to ISDN in the same way that usage charges are applied to non-ISDN services. For example, if a service is a flat rate POTS service, it is available as a flat rate ISDN service. The authors recommend acceptance of this principle. Rules against mixing flat and measured services at the same premise are common and acceptable.

Packet Switched Services: Packet switched data is not available on a POTS line. Policies developed for POTS are not necessarily appropriate for packet switched services. Usage charges for packet switched services should not constitute "measured service" when interpreting the prohibition of mixing flat and measured services. Charges for packet switched services delivered on ISDN lines should not exceed those applicable to other access arrangements to the packet network. Generally, usage rates within customer classes should be the same regardless of access but considerations of promoting ISDN services may justify a lower rate. If customers are known to be concerned that a usage based rate may result in unexpected, unacceptably high billings, then a cap on usage charges could be instituted.

Other Jurisdictions: Experience with ISDN is limited, particularly noncentrex based ISDN. In discussions with ISDN personnel in each of the Regional Bell Holding Companies the authors were not able to obtain specific numbers of ISDN lines in service. When successful deployment was reported, the information was anecdotal. The authors received many comments regarding the need for the Company to work with individual customers and their CPE vendors initially to achieve proper functioning of the equipment.

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The following table shows the tariffed prices for single-line business ISDN in other jurisdictions.



2B + D

(1 B Voice, 1 B Alt. Voice/Data and D Packet Data)

Tariffed States
Monthly Charge
Ameritech 4 $36.46-41.10
Bell Atlantic 0 N/A
BellSouth 0 N/A
NYNEX* 3 $29.00-89.00
Pacific Bell 1 $26.85
Southwestern Bell 1 $55.50
U S West 2 $85.00
*Note: Prices include Federal Communications Commission End User Common Line Charges and do not include usage.

The limited experience with single-line ISDN precludes any analysis of price elasticity for the service. The experience to date indicates that at current prices, there are customers desiring the service who find it difficult to locate suitable CPE and arrange for connection. This indicates that the local exchange company's efforts to facilitate solutions to these nonprice problems initially may be more important than price.

Vertical Services: The modern telephone network provides many opportunities for the customer to enhance the value of telephone service by selecting additional features. These additional features are of increasing importance within the total revenues of the operating companies. Generally, additional features are high-margin services for the companies. The authors recommend that comparable features should not be priced higher for ISDN lines then they are priced for POTS lines.

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The "TouchStar"[2] services are of specific interest. These services are closely related to ISDN in that the digital office requirements for each are the same. Current rates for TouchStar services (excluding caller ID which is addressed separately in this report) are three to four dollars for residential and slightly more for business customers. These prices are generally thought to be substantially higher than the marginal costs of provision in a feature-rich digital network. If the network were made digital, principally to provide these services, then a cost causation case could be made for relatively high rates. However, if there is the presumption that the digital network is deployed for other reasons and these services become available incidental to network evolution, lower prices would be indicated. However, the authors are concerned that reducing prices for vertical services provided over ISDN access lines below the costs of the same services via POTS would make the Company less inclined to encourage ISDN services. The authors therefore do not recommend reductions in vertical services rates. The authors do point out that the these services have higher margins than customer access services, thus total net revenues from ISDN lines will be higher than implied by studies considering only access costs and revenues.

Caller ID: Caller ID is a capability that is integrated in the ISDN offerings. It is available as a vertical service option to POTS in exchanges with a suitable serving office. Clarification of the status of this feature is important when comparing POTS and ISDN prices. The authors recommend that the price of caller ID as an enhancement to POTS not be included in POTS/ISDN price comparisons.

The current prices for caller ID ($7.50 business, $6.00 residential) appear to be based on the assumption that it is a discretionary service, possibly chosen to maximize short-term revenues. At any rate, prices do not appear to reasonably reflect the marginal costs of the capability within a feature rich digital network with high utilization of the network by customers. Customer acceptance of caller ID at these rates can be expected to be low, so caller ID enhancement does not represent the norm for POTS. The inseparability of caller ID from ISDN means that it will be the norm for ISDN service. Just as ISDN inherently provides the customer with access to additional channels for communication, it inherently provides the caller ID feature. Rate comparisons should be made between the norm of POTS (caller ID) and the ISDN norm.

Continuing Oversight: The TPSC has sponsored the concept of advanced telecommunications as a means to economic success and improved quality of life for the State. To achieve these ambitions requires more than the availability of the services, it requires that they are used by the customers. ISDN is a new telecommunications technology. The preceding sections of this report have addressed the issues of rates and tariff structure. These are not the only relevant considerations. Communications with

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customers regarding the availability and capability of the service and implementation assistance to the customers is perhaps even more important than either rates or tariff structure. ISDN is a good product. The Commission will arrive at a fair rate and reasonable tariff terms. It is incumbent upon the Company to effectively market the concept and the services.

The Commission should choose some means of assuring that the marketing efforts of the Company are effective. Available choices are incentive mechanisms which the Commission judges adequate to assure appropriate Company performance, and requiring the Company to submit detailed specification of a marketing plan.

The Commission may judge that the rate it establishes provides all of the necessary incentive to assure adequate marketing performance by the Company. If the Company is better off providing ISDN services than POTS services, it will be inclined to encourage customer adoption of ISDN. A primary indicator of the comparative advantage of ISDN services to the Company is the rate differential between ISDN and POTS. As the differential is reduced, the Company's self interest in promoting ISDN is lessened. If the differential is minimized, the Company may have little incentive to promote the adoption of ISDN by its customers. The authors have recommended ISDN rates that tend to minimize the differential. Should this recommendation be adopted, the authors believe that additional regulatory initiatives should be undertaken to address the marketing effort issue. A separate incentive mechanism could fulfill this need, or a marketing oversight plan could be devised.

The authors are aware of discussions in Tennessee of a specific incentive mechanism to encourage the Company to successfully market the services. The authors believe that measuring progress in terms of the numbers of customers using the service is appropriate. The authors have not evaluated the reasonableness of the level of the incentives discussed. Such an evaluation is outside the scope of the authors' work. However, the authors concluded that an incentive mechanism rewarding the Company for each ISDN line connected comports with the authors' understanding of the Commission's public interest objective of rapid adoption of advanced telecommunications technology.

If the Commission concludes that a separate incentive mechanism is inappropriate and that the incentive inherent in the rate differentials authorized are insufficient to assure adequate marketing efforts by the Company, then additional regulatory oversight is necessary. In that event, the authors recommend that oversight take the following form.

First, the Commission should establish a minimum level of customer adoption of ISDN that is deemed adequate to satisfy the public interest objectives. After reviewing the Plan, the authors conclude that the plan's objective may be 50 percent of the lines with digital connection to the network within approximately six years. To achieve that level

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suggests that 8 percent of business single lines be ISDN within three years of approval of the tariff. Interim objectives should be 2 percent business single lines within one year and 4 percent single business lines within two years. For residential lines, the authors expect a somewhat delayed adoption of the new technology and suggest that the 2 percent level be reached within two years, and 4 percent within three years. The authors do not believe that a one-year residential objective should be established.

The choice of the objective for the percentage of ISDN lines is the Commission's choice. As indicated, the authors interpreted the Plan as supporting 50 percent penetration of total South Central single lines in six years. This would be a very substantial achievement. If other expectations are set, the authors would suggest that they be developed by choosing a penetration level of 50 percent or less as of a defined year and using a geometric progression to estimate the intermediate years required progress. An expectation of doubling the number of lines each year during initial deployment is reasonably a geometric progression, in that it approximates the "S" curve life cycle experience common to virtually all technological deployments and is easily calculated.

The authors do not recommend establishing penetration criteria beyond three years. Newer technologies may be introduced causing the most advanced users to move beyond ISDN. The ISDN applications may make ISDN even more popular with single-line users than implied by the initial objective or failure to identify popular, affordable applications may make the objective unreachable. At any rate, it is not likely that marketing plans would be greatly affected by long-term criteria. The Commission may wish to update the criteria periodically in the future, maintaining a two to three year objective horizon.

Second, the Commission should require the Company to initially outline its three-year marketing plan and the Commission should require modifications, if necessary, to ensure that the plan is adequate. The outline should address budget levels for marketing, including numbers of personnel dedicated to the ISDN marketing efforts and the general work assignments of the personnel. The plan should address each of the following areas:

1. Factors that the Company controls:

a. The availability of ISDN service to individual customers.

b. The ease with which the service can be established.

c. Facilitation of the "partners" in meeting customer needs

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2. Factors that the Company influences:

a. Pricing of the service

b. Customer understanding of the service's potential

c. Vendor understanding of the market's potential

d. Availability of equipment to end-users

e. Development of useful applications

f. Help for customers to develop targeted applications

g. Availability of software for end-users

h. Interface with interexchange carriers and other carriers

1. Technical issues

2. Business issues

Once the Commission is satisfied with the details of the marketing plan, the authors recommend that the Company be required to submit progress reports every six months. These periodic reports should update the status of the marketing effort and report the number of customers choosing ISDN services. If the numbers of customers subscribing to ISDN fall below the targeted levels, the Commission should conduct an investigation of the causes and issue such orders as are appropriate to the circumstances.

Reasonableness: The authors have made several recommendations in this report that would either impose additional costs upon the Company, which are not directly reflected in cost studies, or recognize that revenue opportunities probably exceed marginal costs. The authors did not consider the potential for revenue loss from customers currently using multiple POTS lines moving to fewer ISDN lines. The authors do not recommend that adjustments to cost studies be made for these deviations from the principles of cost/rate matching. The cost studies are estimates, and probable deviations in both directions were identified.

Tennessee uses a total Company, jurisdictional revenue requirement basis for the regulation of South Central Bell. This powerful tool assures a reasonable result over time for both customers and the Company. Service specific cost studies are extremely valuable for establishing individual rates but have limitations. Principal among the limitations is the lack of assurance that jointly incurred costs are all accounted for without any double counting. The principles used to allocate costs and even the costs to

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be allocated are insufficiently specific to assure that the rate element by rate element studies will yield a reasonable result. Only observation of the total jurisdictional performance of the Company operating as an integrated whole provides a dependable assessment of the net result of all the regulatory and business decisions that impact the net revenue of the Company.

For example, the authors have recommended that residential preferences existing for POTS service be maintained for ISDN services. The POTS preferences are imbedded in the Company's operating results and in the projections of future revenues and costs. Their reasonableness is implicitly evaluated in the total jurisdictional assessments of the Commission. Preserving those preferences for ISDN residential services preserves the underlying conditions of the operating results used by the Commission in evaluating Company financial performance.

The authors recommend that the Commission continue to use total Company jurisdictional revenue requirement as a primary foundation for the regulation of the Company.

Tennessee ISDN Final Order: On January 25, 1994 the Final Order of the TPSC adopted the recommendations contained in this report with the exception of the business rates for basic rate ISDN. (See Quarterly Bulletin 15:1, 179.) The business rates were based on a revenue-loss study performed by South Central Bell. The residential ISDN rates for 2B + D by rate group are as follows:

Rate Group 1 $21.40
Rate Group 2 $22.35
Rate Group 3 $22.90
Rate Group 4 $25.70
Rate Group 5 $26.00

The B channels will be flat rated.

In addition, the packet usage charge on the D channel and customer installation charge are waived for the first year.

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The business ISDN rates for 2B + D for all rate groups are as follows:

1D $87.00
1B $71.25
1B + D $83.25
2B $87.50
2B + D $99.60

The above business rates include touchtone and caller ID Other features will be at an additional charge. The B channels will be flat rated, D channels will be measured at $.20 per kilosegment (8,000 characters). Business line installation charges will be $58.50, the same as a local business line.

In addition to these rates, the TPSC extended the residential rates to educational institutions. The TPSC adopted the penetration rates contained in this report as targets for SCB. The Company was required to submit a three-year marketing plan and consumer education plan within sixty days of the date of the Order.

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[1] The views and opinions expressed by the authors are not necessarily those of The National Regulatory Research Institute, the National Association of Regulatory Utility Commissioners, or any particular state public utility commission.

[2]Registered service mark of BellSouth Corporation.

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