FCC’s FNPRM Proposes Two Alternatives for Defining Contributions Base

On April 27, 2012, the FCC approved a FNPRM to tackle the seemingly-impossible mission of reforming the Universal Service Fund contributions methodology—the FNPRM was subsequently released on May 1. There was a time in the not-so-distant past when USF distributions and ICC reform seemed impossible too, but the FCC did it anyway. Like the disbursement and ICC components, the FCC has been wrestling with USF contributions reform for the better part of a decade. A closer look at the FNPRM actually reveals that reforming the USF contributions methodology will rustle some of the age-old telecommunications industry semantic debates like “what is a telecommunications provider?” Needless to say, the FCC still has a bumpy and controversial journey ahead before the ultimate National Broadband Plan goal of wholly transforming every facet of the Universal Service Fund is completed.

The FNPRM asks some very poignant questions and seeks input about the telecommunications and broadband marketplace of today and the future. The FCC hopes to ultimately adopt a “future proof” contributions methodology, which is surely impossible but nevertheless an ambitious goal. The proposed reforms are broken into several categories: who should contribute to the fund; what methodology should be used to assess contributions; what administrative reforms will promote transparency and clarity; and how contributions should be recovered from consumers. The FCC lays the foundation for the reforms with three goals: efficiency, fairness, and sustainability. As the 182-page FNPRM contains an abundance of interesting and discussion-worthy issues, JSICA will break up our analysis based on the general reform categories. Up first, and likely the most controversial, is the question of who should contribute to the USF.

The FCC asserts that “The evolution in the communications ecosystem has led to a series of stresses on the contributions system.” Namely, it has become increasingly complex and the contributions base is rapidly shrinking as consumers “migrate to communications services that do not contribute to the Fund.” Faced with a shrinking contributions base, an $8b total USF budget, and a record-high contributions factor of 17.9%, the time is nigh to rethink the contributions methodology—especially the categories of providers who contribute to the fund. The FCC rightly acknowledges that, “The question of who should contribute is at the core of much of the uncertainty and competitive distortions that plague the system today.”  In the FNPRM, the FCC proposes two possible alternatives for reforming the contributions base, but seems open to considering other ideas from the industry.

The first alternative is for the FCC to use its “permissive authority, and/or other tools to clarify or modify on a service-by-service basis whether particular services or providers are required to contribute to the Fund.” The second is to adopt “a more general definition of contributing interstate telecommunications providers that could be more future proof as the marketplace continues to evolve.” The two alternatives appear to have distinct advantages, challenges, and disadvantages. Both options will surely incite some provocative legal debates regarding the definition of a “provider of interstate telecommunications service” as well as the FCC’s statutory authority to include or exclude certain services in the USF contributions base.

The first alternative, the “case-by-case” methodology, would essentially let the FCC “expand or clarify contribution obligations on a service-specific basis.” The FCC notes that it has used this approach in the past, but asks if it should be continued under the reformed system. The FCC broadly explains, “We seek comment on exercising our permissive authority to require contributions from providers of enterprise communications services that include interstate communications; text messaging; one-way VoIP; and broadband Internet access service. Each of these services has found a significant niche in today’s communications marketplace.” The FCC continues with market data and specific questions about the inclusion or exclusion of each of these categories of services. Of particular importance, the FCC asks if assessing contributions on broadband service would increase the price of broadband to the extent that the goals of the Connect America Fund are somehow negated.

The second approach would be much more expansive, and “would not require [the FCC] to resolve the statutory classification of specific services as information or telecommunications services in order to conclude that contributions should be assessed.” The language of the proposed rule is as follows: “Any interstate information service or interstate telecommunications is assessable if the provider also provides the transmission (wired or wireless), directly or indirectly through an affiliate, to end users.” Seems simple, right? Well, it’s not. As the lines between information, telecommunications, transmission, end-user, content, and so on become increasingly blurry, so may the ability to assess USF fees on such a generalized basis.

The FCC attempts to clarify that “the rule set forth above is intended to include entities that provide transmission capability to their users, whether through their own facilities or through incorporation of services purchased from others, but not to include entities that require their users to ‘bring their own’ transmission capability in order to use a service.” The FCC could avoid a dicey statutory classification fiasco, but it would still have to determine if the service is “interstate telecommunications.” The FCC provides several examples of how this rule could quickly become a regulatory quagmire when it comes to interpreting who is a “user” of telecommunications service, and what are the specific “points of transmission.” One example cited is that of an e-book provider who sells a device bundled with service coming from a separate wireless carrier. Is the end-user the customer who downloads a book over the wireless network, or the e-book/device purveyor? Is the e-bookseller “providing telecommunications,” or is the wireless carrier? Who contributes to USF? As you can see, these questions get rather esoteric.

Under the context of this second proposed rule, the FCC opens up a discussion on one category of services which is likely to incite a passionate debate in the comment cycle: machine-to-machine, or M2M connections. The FCC explains that M2M connections have grown rapidly in recent years, and it asks “would it be consistent with our statutory authority to exercise permissive authority over machine-to-machine connections, such as smart meters/smart grids, remote health monitoring, or remote home security systems?” The FCC further asks—and this one is a real head-spinner—“Should machine-to-machine connections be treated the same as connections between or among people?” The responses from the industry will surely be interesting.

As with the first option, the FCC asks if the second option could have adverse effects on the overall USF goal of bringing broadband to all Americans. The FCC specifically asks if the assessment of contribution obligations under the broader second alternative would “deter adoption” of broadband services, presumably by increasing the price. This kind of begs the response, “Well, did assessing universal service contributions on telephone service deter the adoption of telephone service?” One can anticipate that broadband service providers and other current non-contributors will likely argue that assessing contributions fees on their services will indeed deter adoption. However, the FCC notes in its discussion of text messaging that it will consider commenters’ financial stake in the position that they advocate, and commenters should come to the table equipped with data to back their claims.

Stay tuned for JSICA’s next installment on this topic, analyzing the assessment methodologies outlined in the FNPRM. Meanwhile, feel free to discuss your thoughts on how the contributions base should be reformed on JSICA’s LinkedIn USF Forum.

List of Capped Companies Plummets from 283 to 106 in QRA 2.0

It appears as though the Wireline Competition Bureau has paid attention to the hundreds of filings, letters, and ex parte meetings from the rural independent telecom industry over the last few months, because the new version of quantile regression analysis (QRA) released on April 25, 2012 actually makes more than a few minor changes closely based on RLEC input and recommendations. The “Benchmarks Order” was released late in the day along with a separate Second Order on Reconsideration addressing CAF Phase I and VoIP ICC and a new website for CAF resources on FCC.gov. Overall, the FCC made some profound changes to QRA—changes that the RLEC industry will likely applaud, and changes that may prevent several hundred companies from facing financial distress before the end of the year.

Going back to the USF/ICC Transformation Order, the FCC approved regression analysis as a methodology for limiting high-cost support. The FCC felt that some RLECs were simply receiving too much money from the fund, and “these carriers generally faced no overall limits on their expenditures.” In the Order, the FCC proposed a specific quantile regression analysis methodology in Appendix H, and put it up for comment in the FNPRM. RLECs were overwhelmingly against the proposed methodology (you can read about this more here, here, here, and here). RLECs unleashed a storm of fury and frantically tried to figure out how the proposed caps would impact their investment and capital over the next few years, only to find that it was literally impossible to predict anything beyond 2012.

The RLEC industry provided countless examples of why the original QRA was arbitrary and capricious, why the FCC’s underlying data was wrong, and why the methodology failed to meet the standards of predictable and sufficient support. Furthermore, RLECs took their concerns to Congress, and dozens of Senators and Representatives responded by pressuring the FCC to revise the methodology. In the last two weeks, over two dozen companies have filed letters of intent to file waivers if the FCC adopts the original methodology. And one last thing—government economists who reviewed the methodology a couple months ago also suggested a variety of changes, arguing that the FCC basically got it wrong.

JSICA will dig deeper into QRA 2.0 and the Benchmarks Order over the coming weeks; meanwhile we offer an overview of the changes. The FCC explains that it made the changes “in response to the comments from two peer reviews and interested parties and based on further analysis by the Bureau. These changes significantly improve the methodology while redistributing funding to a greater number of carriers to support continued broadband investment.” Notable changes include:

• 106 carriers are capped, instead of the previous 283.
• For the capped carriers, the reduction in HCLS will be phased in between July 1, 2012 and January 1, 2014.
• The “savings” from capping the 106 companies will amount to about $65m, in contrast to the previously estimated $109m. $55m will be redistributed to the uncapped carriers for broadband investment.
• QRA is now used to generate a capex limit and an opex limit for each company, rather than to generate limits for 11 separate Study Area Cost per Loop algorithm lines. As the FCC notes in the Order, this is “the most significant change in the methodology,” and the decision “reflects a balancing of considerations.” The FCC also notes, “Using fewer regressions limits the Commission’s ability to identify outliers, but enables carriers to account for the needs of individual networks and recognizes the fact that carriers may have higher costs in one category that may be offset by lower costs in others.” This is indeed an important realization and compromise.  
• The FCC changes the definitions of capex and opex. It now defines capex “as the plant-related costs in step twenty-five, which includes return on capital and depreciation, and [defines] opex as the remaining components that are added in step twenty-five to calculate total costs.” It is important to note that the FCC now accounts for depreciation in the capex definition.
• The FCC made significant changes to the selection of independent variables used in QRA by adding a variety of robust and descriptive variables and proxies. A full list of the variables is available in Appendix A of the Order, but some of the notable additions include road miles, road crossings, climate, soil difficulty and bedrock depth. The FCC also includes special variables for Tribal areas, Alaska, the Midwest, and the Northeast.
• The FCC acknowledged the widespread criticism of the TeleAtlas study area boundary data, but declined to modify the study area boundaries in the new methodology. However, the FCC will “provide a streamlined, expedited waiver process for carriers affected by the benchmarks to correct any errors in their study area boundaries.” Additionally, the FCC will solicit data from RLECs about study area boundaries and update the regression methodology in 2014 based on this data. The FCC will also generously waive the $8k waiver fee for carriers seeking a study area boundary waiver.
• The new methodology includes an independent variable that captures the age of the plant—this is important, because it will help differentiate carriers that have invested recently from carriers that have not invested recently. The FCC explains, “Adding this variable raises the cost limit for carriers that have invested recently.”

Some aspects of QRA were not changed, and the FCC rejects several arguments presented by the RLEC industry about QRA. First, the FCC is keeping the ninetieth percentile threshold for now. RLECs previously argued that the FCC should increase the threshold because the caps themselves were overly-inclusive. Under the new methodology, significantly fewer companies are capped which the FCC believes justifies the ninetieth percentile threshold: “We conclude that using the ninetieth percentile as part of the revised methodology appropriately balances the Commission’s twin goals of providing better incentives for carriers to invest prudently and operate more efficiently.”

Second, the FCC rejected the notion that QRA constitutes retroactive ratemaking because “it cannot fairly be said that the application of these benchmarks will take away or impair a vested right, create a new obligation, impose a new duty, or attach a new disability in respect to the carriers’ previous expenditures.” The FCC also notes that it is now phasing in the caps over 18 months, which “provides a greater opportunity for carriers to make any necessary adjustments.” Lastly, the FCC rejects the notion that QRA is a slap in the face of the USF principles of predictability and sufficiency—on the contrary, the FCC believes “if anything, support will now be more predictable for most carriers because the new rule discourages companies from exhausting the fund by over-spending relative to their peers.” Additionally, “the very purpose of the benchmarks is to ensure that carriers as a whole receive a sufficient (but not excessive) amount of HCLS.”

QRA 2.0 is drastically, profoundly, tremendously different from the initial methodology proposed in the USF/ICC Transformation Order. There are sure to be at least a couple “devils in the details,” but for the most part it appears as though the FCC really did listen to and accept the arguments made by the RLEC industry in response to QRA 1.0. In addition to developing a more robust and realistic methodology, the FCC is inserting a reasonable transition period whereby RLECs can prepare for the caps in a gradual manner. What do you think about QRA 2.0—what do you like and dislike the most? Will the changes have a positive impact on RLEC broadband investment over the next 18 months?

RLECs' Extended Family Calls on FCC to Promote Rural Economic Growth

On April 24, 2012, a group of professional service and vendor firms wrote a letter to FCC Chairman Julius Genachowski, explaining that the USF/ICC Transformation Order conflicts with the goals of the American Recovery and Reinvestment Act of 2009 (ARRA), and “will ultimately undermine job creation and retention gains envisioned by ARRA.” The signatories of the letter include representatives from the following firms that support the rural telecom industry: CHR Solutions, Consortia Consulting, HunTel Engineering, Kadrmas Lee & Jackson, Ladd Engineering, Mapcom Systems, Monte R. Lee Engineering, National Information Solutions Cooperative, Palmetto Engineering & Consulting, RVW, Inc., and TCA.

These parties have a vested interest in USF/ICC Reform, just as we do at JSI Capital Advisors. According to the letter, “Collectively, we employ more than 2,000 people and generate annual revenues exceeding $265m in both rural and urban areas. Our firms provide network construction and maintenance, engineering and environmental services, software and systems development, and accounting and financial services.” They continue, “We are precisely the type of firms that create and retain jobs as intended by the ARRA.”

Despite their success in serving the rural telecom industry, the signatories of the letter now face significant challenges along with the companies they serve—that’s because RLECs don’t operate in a vacuum, regardless of what the FCC may or may not believe. If regulatory uncertainty causes RLECs to scale back investment, it is likely that professional services and equipment vendors will take a direct hit, too. The letter explains, “We are seeing economic activity in this sector slow, and in many cases stall altogether, largely as a result of changes and lingering regulatory uncertainty arising out of recent Commission action…The already-adopted reductions, combined with proposed future cutback, are undermining market confidence in continued rural broadband investment.”

The letter further explains how the funding cuts imposed by USF/ICC reform run contrary to the White House Administration’s goals in ARRA: “the cuts…are causing our clients and their investors to either scale downward or eliminate entirely new deployment initiatives, and consequently, the material inputs they require from us. In sum, the Commission measures are discouraging economic growth, limiting broadband investment, and stalling job creation.” The parties call these impacts of USF/ICC reform “anti-stimulus” and then they call on the FCC to “temper swiftly those adverse measures already adopted, and defer action on pending items until the impact of new requirements is evaluated and absorbed.”

From the perspective of vendors and professional service firms who primarily serve the RLEC industry, it may be easy to see the glass as half-empty with a giant crack in the bottom. However, new opportunities may arise from the USF/ICC debacle if patience perseveres. There is certainly an impending need for professional service firms to help navigate their clients through the new regulations, prepare filings at the federal and state level, guide strategic planning efforts, and ensure compliance with the new requirements.

Equipment vendors—software, hardware, fiber, etc.—may find opportunities where RLECs are looking to upgrade to more efficient operations—after all, this is one of the primary intentions of the Order. The FCC encourages RLECs to consolidate softswitching operations and look for other scale efficiencies (hint: the FCC wants RLECs to consolidate in general)—but this is an opportunity for equipment vendors. I may be teetering on a shaky limb here, but if quantile regression analysis is modified based on input from the rural industry and ulitmately works the way the FCC intends (without the accompanying “parade of horribles” anticipated by RLECs), companies may look for new ways to operate more efficiently, which could mean new investment in various categories of central office equipment and network infrastructure. Other RLECs will seek opportunities for new revenue streams through edging out their networks, participating in CAF and Mobility Fund auctions, offering new broadband-enabled video services, and expanding into other unregulated markets like data storage and home security. The FCC is also pushing the transition from PSTN to IP, which presents myriad opportunities for engineers, consultants, and equipment vendors. In all of these scenarious, there are bountiful opportunities for vendors and professional service firms who are willing to be patient while their RLEC customers and clients modify strategic plans in light of the regulatory changes.

If USF/ICC reform works as it is intended, boosts the goals of the ARRA, and promotes investment across the rural telecom sector, then rural Americans will benefit from universal broadband and economic growth. The professional service firms and vendors who signed the letter described above comment that they “trust the Commission did not intend” for the results that the RLEC industry is currently bracing for—vast cutbacks in investment, abandoned broadband projects, possible financial insolvency in the most severe cases. Several other commenters in waiver and ex parte filings have also said that they trust that the FCC did not outright intend to cause great harm to the rural telecom industry.

So—do you trust that the FCC did not intend to bring down mass destruction on the RLEC industry and its extended family of vendors and professional service firms, or do you just not trust the FCC at all? Share your thoughts on JSICA’s LinkedIn USF Forum.