Before the
FEDERAL COMMUNICATIONS COMMISSION
Washington, D.C. 20554
In the Matter of )
)
Implementation of the ) CC Docket No. 96-128
Pay Telephone Reclassification )
and Compensation Provisions of the )
Telecommunications Act of 1996 )
THIRD REPORT AND ORDER, AND
ORDER ON RECONSIDERATION
OF THE SECOND REPORT AND ORDER
Adopted: January 28, 1999 Released: February 4, 1999
By the Commission:
Table of Contents
Paragraph No.
I. INTRODUCTION 1
A. The Commission's Prior Orders 2
B. The 1996 Act and Market Constraints 9
C. Summary of Our Actions in this Order 13
II. BACKGROUND 19
III. THE ECONOMICS OF PAYPHONE TELEPHONY 29
A. Payphone Costs and Revenues 30
B. Competition Among Payphones 34
C. Possible Market Failures Relating to Dial-Around Compensation 40
D. The Common Cost Allocation Problem 45
IV. DISCUSSION 48
A. Remand Issues 48
1. Definition of Compensable Call 51
2. Definition of Fair Compensation 54
3. Reconsideration of Second Report and Order's
Top-Down Methodology 60
a. TOCSIA and Targeted Call Blocking 64
b. Recovery of Joint and Common Costs 69
c. MCI v. FCC 71
4. Selection of a Bottom-Up Methodology 72
5. Conclusions and Response to the Court 88
B. Reconsideration Issues 89
1. Overview 90
2. Alternative Compensation Methodologies 94
a. Duration Methodology 95
b. RBOC Coalition's Ramsey's-Style Pricing
Methodology 100
c. Bellwether Methodology 112
d. Caller-Pays Methodology 114
e. Requests for Exemptions from Compensation 117
3. Cost Calculation 122
a. Source of Cost Data 123
b. Use of Marginal Payphone Location 139
c. Location Rents 154
d. Coin Mechanism 157
e. Bad Debt 160
f. Dial-Around Collection Costs 163
g. Components of the Cost Calculation 165
(1) Payphone Capital Expense 165
(2) Line Charge Costs 170
(3) Maintenance Costs 175
(4) Sales, General, and Administrative Costs 178
(5) Coding Digit Costs (FLEX ANI Costs) 180
(6) Interest 187
(7) Marginal Cost of a Payphone Call 190
(8) Default Compensation Amount 191
(9) Top-Down Calculation 192
4. Compensation for October 7, 1997 to Present 195
5. Method of IXC Overpayment Recovery 197
6. Other Issues 200
V. PROCEDURAL MATTERS
A. Paperwork Reduction Act Analysis 201
B. Supplemental Final Regulatory Flexibility Act Analysis 202
VI. CONCLUSION 228
VII. ORDERING CLAUSES 232
APPENDIX A Amended Rules
APPENDIX B List of Parties
I. INTRODUCTION
1. In this proceeding, we continue our efforts to implement the requirements of
section 276 of the Telecommunications Act of 1996 ("the 1996 Act"). Section 276 directs us to
promulgate regulations that will achieve three basic policy objectives with respect to the
provision of payphone services: (1) promoting a competitive payphone market; (2) ensuring the
widespread deployment of payphones for the benefit of the general public; and (3) ensuring that
providers of payphone services receive fair compensation for every call made using their
payphones. The overarching goals of the 1996 Act further instruct us to establish these
regulations in a pro-competitive, deregulatory framework that will open up telecommunications
services to competitive forces nationwide. In this Order, we also respond specifically to issues
remanded to us by the Court upon its review of the Commission's previous order.
A. The Commission's Prior Orders.
2. In the prior orders in this proceeding, the Commission has fulfilled much of the
congressional mandate embodied in section 276 by creating the structural groundwork necessary
for competition to flourish in the provision of payphone services. For example, the Commission
eliminated implicit subsidies to payphones provided by local exchange carriers (LECs) that gave
such companies an unfair competitive advantage compared to non-LEC payphone providers.
Similarly, the Commission established non-structural safeguards to prevent Bell Operating
Companies (BOCs) from discriminating in favor of their own payphones in the provision of local
service, as well as other measures designed to place all providers of payphone services on an
equal competitive footing. The Commission also deregulated the local coin rate for payphone
calls to allow the competitive marketplace to set fair compensation for such calls. None of these
actions is implicated by the steps we take in the instant order.
3. The Commission has adopted two prior orders aimed at balancing the policy
objectives identified above. In these prior orders, the Commission gave primary importance to
Congress's objective of establishing a market-based, deregulatory mechanism for payphone
compensation, as required both in section 276 and the generally pro-competitive goals of the
1996 Act. The Commission recognized, however, that various statutory, technological, and
economic factors inhibited the development of a fully deregulated means of providing fair
compensation for certain types of calls broadly referred to as "dial-around" calls for which
payphone owners were largely uncompensated prior to the 1996 Act. Indeed, the Telephone
Operator Consumer Services Improvement Act (TOCSIA) limits the ability of payphone service
providers (PSPs) to negotiate with interexchange carriers (IXCs) fair compensation for dial-
around calls. Unlike other aspects of payphone service, such as the local coin rate, the
Commission accordingly found it necessary to adopt a more regulatory approach to ensuring that
PSPs are fairly compensated for these types of calls.
4. By way of explanation, there are typically three types of calls made from
payphones: local calls; long distance calls using the long distance carrier selected by the
payphone owner (referred to as the "presubscribed carrier"); and so-called "dial-around" calls,
where the caller makes a long distance call using a long distance carrier other than the
payphone's presubscribed long distance carrier.
5. Payphone owners receive direct payment for providing the first two categories of
calls. For example, a caller making a local call deposits coins (typically $.35) and is connected
to the called party. That $.35 is paid directly to the payphone owner. A caller making long
distance calls using the payphone's presubscribed long distance carrier dials the long distance
number, and the payphone owner typically receives payment through its presubscribed carrier.
6. The third category, referred to as "dial-around" calls, consists of long distance
calls that utilize a long distance carrier other than the payphone's presubscribed carrier.
Generally, there are two types of dial-around calls. The first type is where a caller uses a code to
access his preferred long distance carrier to make a long distance call, e.g., "1/800/CALL-
AT&T" or "10-10-321." The second type of dial-around calls are known as "toll-free" calls, such
as 1/800-FLOWERS. In this type of call, the flower company will pay (or "subscribes" to) a
long distance carrier for a toll-free number that its customers can use to make long distance calls
to the company. Similar to the caller who uses 1/800-CALL-ATT, the flower customer calling
from a payphone is making a long distance call using a carrier other than the payphone's
presubscribed long distance carrier. This Order addresses the question of how payphone owners
should be compensated for "dial around" calls made from their payphones.
7. In its prior two orders, the Commission established a phased-in compensation
mechanism to satisfy the statutory mandate to ensure that payphone owners are "fairly"
compensated for these dial-around calls. The first phase of the compensation mechanism
established a specific, per-call default compensation amount to be paid to a PSP to cover the cost
of an access-code call or toll-free subscriber call in the absence of a negotiated agreement
between the PSP and the carrier handling the call. In the Second Report and Order, the
Commission calculated this default amount using what might be described as a "top-down"
approach. That is, the Commission used the typical deregulated coin rate of $.35 as a starting
point and subtracted net avoided cost differences between the provision of these coin calls and
the provision of "dial-around" or compensable calls. The second phase used the same "top-
down" methodology to determine a default amount but allowed the "starting point" to vary with
the deregulated coin price at each individual payphone.
8. As detailed below, both of the Commission's orders establishing a mechanism for
setting "fair compensation" for access code and toll-free calls were appealed. While upholding
most of the other market-opening undertakings described above, the Court in both instances
found fault with the Commission's efforts to tie "fair compensation" for these dial-around or
compensable calls to the deregulated prices charged by PSPs for local coin calls. In particular,
the Court, in its second remand order, found that the Commission failed to adequately articulate
why the price of a local call is an appropriate starting point for deriving a regulated default price
for "dial-around" or compensable calls. The Commission's main rationale for this approach was
that it could be viewed as being fair in the sense that the margin between price and incremental
cost would be the same for all types of calls. Thus all types of calls could be viewed as making
the same contribution to covering joint and common costs. Thus our justification for choosing
$.35 as a starting point was simply that it could be viewed as producing a "fair" result.
B. The 1996 Act and Market Constraints.
9. In this Order, we must reevaluate the appropriate means by which to achieve the
basic policy objectives expressly set out in section 276. In setting a default compensation
amount, the present realizing any of these goals individually will not be the optimal means of
satisfying one or more of the other goals. For example, the market for payphone services is
characterized by increasing competitive pressures due, in part, to the market-opening directives
of our previous orders in this proceeding. Additional pressures have arisen from payphone-
market substitutes, i.e., the rapidly growing availability of Personal Communications Service
(PCS) and cellular technology, which provides some consumers with an economic alternative to
payphones. In a competitive payphone market, these factors certainly may lead to a reduction in
the deployment of payphones in some areas, particularly in low-volume locations. Moreover, the
number of payphones deployed across the country is inexorably related to our determination of a
fair compensation amount, as we are directed to do by Congress. Simply stated, a higher default
compensation amount will lead to the deployment of more payphones, and a lower default
compensation amount will lead to fewer payphones, irrespective of which rate represents "fair
compensation." Another example arises from the Congressional mandate that the Commission's
compensation methodology be established on a "per call" basis. Because the overwhelming
majority of a payphone's costs are fixed, a per call compensation plan results in the following
anomaly: A payphone with a low number of calls, e.g., in a rural area where few calls are made
from the phone, will just barely recover its costs. Under the same plan, a payphone with a high
number of calls, e.g., a payphone in a busy bus station, will recover much more than its costs.
10. We place great weight on Congress's directive to ensure that payphones remain
widely deployed and available to the public at large, in part, because we believe that, if we fail to
adequately compensate payphone owners for dial-around or compensable calls, the first
payphones likely to be eliminated are those payphones located where consumers have the fewest
real alternatives, such as in rural areas that generate relatively fewer payphone calls and inner-
city areas with low residential subscription rates. We also give primary importance to Congress's
objective of widespread deployment because the public benefits from widespread deployment.
Furthermore, the accomplishment of the remaining objectives necessarily flow from widespread
deployment, e.g., to ensure widespread deployment, there must be fair compensation.
11. After considering the record before us and the opinions of the Court, we conclude
that the existing statutory, technological, and economic constraints identified in the
Commission's prior orders prevent us at this time from relying upon deregulation to determine
fair compensation for access-code and toll-free subscriber calls. Nothing in the record before us
persuades us that we should reconsider our characterization of the competitiveness of the
payphone market in the First Report and Order.
12. In contrast to the provision of local coin call service, however, the provision of
access-code and toll-free call service is subject to statutory and technological restrictions that
presently inhibit the ability of the parties to the transaction to reach a mutually agreeable price,
or, alternatively, to decline to transact. In particular, Congress previously mandated in section
226 of the Act that PSPs must provide to consumers using their payphones access to all IXCs.
As a result, PSPs have minimal leverage to negotiate with these IXCs for a fair compensation
amount for delivering calls to the IXCs' networks. Indeed, this concern was one of the
fundamental reasons why Congress adopted the compensation provisions of section 276. In its
previous orders, the Commission sought to overcome this lack of bargaining power by
establishing a system where the IXC could choose to "block," or not accept, calls if it determined
that the price being demanded by the PSP was more than the IXC was willing to pay. We
conclude in this Order, however, that the present ability of carriers to block is not sufficiently
developed to ensure that allowing the default rate to float with the PSP's local coin rate will
necessarily result in a compensation level that is "fair," as contemplated by the statute.
C. Summary of Our Actions in this Order.
13. In this Order, we switch from the top-down methodology of our prior orders to a
"bottom-up" methodology to establish the default per-call compensation amount that shall be
paid to PSPs for compensable calls that are not otherwise compensated. We refer to the
compensation amount as a "default amount" to emphasize that it applies only in the absence of
some other price that may be negotiated between the payphone owner and the carrier. Pursuant
to the bottom-up methodology adopted in this Order, we calculate an average fully distributed
cost for each type of call such that the default price for each type of call is set equal to the fully
distributed cost of that type of call. We call this a "bottom-up" approach to connote the idea that
the price of dial-around or compensable calls is calculated by "building-up" from a starting point
of zero using costs, instead of "building-down" from a starting point of the price of coin calls
using avoided costs. In our explanation of the shift to a bottom-up methodology, we respond to
the concerns of the Court in MCI v. FCC, which remanded the Commission's Second Report and
Order.
14. We adjust the default per-call compensation amount for dial-around or
compensable calls from $.284 to $.24. We make this adjustment both as a result of the new
methodology we adopt and as a result of our resolution of the petitions for reconsideration of the
Second Report and Order. Indeed, as detailed below, this reduction in the default amount is
more the result of new, more accurate cost data submitted in connection with the petitions for
reconsideration than due to the switch from a top-down to bottom-up calculation. In reaching
the revised default amount, we consider the cost data submitted (1) for the Second Report and
Order; (2) in connection with the petitions for reconsideration of the Second Report and Order;
and (3) in response to our Public Notice. Also, we reconsider our treatment of the costs
associated with the provision of compensable calls from payphones. The more-developed record
assures us that our current calculation of a default compensation amount more accurately reflects
the costs of providing payphone service than our previous efforts.
15. Because our bottom-up methodology assures fair compensation for the
overwhelming majority of payphones, we conclude that the per-call compensation methodology
that we adopt in this Order will not negatively affect the current deployment of payphones and
thus will promote Congress's goal of widespread deployment of payphones. In particular, by
using a "marginal" payphone location for purposes of calculating the default compensation
amount, we have sought in this Order to ensure the continued deployment of existing payphones
to the greatest practical extent. Furthermore, nothing in our Order affects or jeopardizes the
states' ability to ensure that public interest payphone programs are viable and supported in an
equitable and fair fashion. We therefore conclude that the per-call compensation methodology
adopted herein is the best option available to implement section 276(b)(2) of the Act in light of
existing technological, statutory, and economic constraints.
16. We believe that targeted call blocking ultimately will play a significant role in
bridging the gap between Congress's and the Commission's goal of a deregulatory solution and
the present state of payphone telephony. Should the parties that are the principal economic
beneficiaries of the payphone market -- the payphone providers, the IXCs, and the subscribers to
toll-free lines -- be unable or unwilling to resolve the technological issues regarding targeted call
blocking, then their inaction may require us to move to a more regulatory approach. If, however,
the parties are able to resolve these technological issues surrounding the availability of targeted
call blocking, we believe that a move to a more market-based approach that would comply with
both statutory obligations and the Court's concerns is foreseeable. We note that IXCs currently
possess the technology and receive the coding digits necessary to implement a targeted call
blocking mechanism.
17. Until such time, we will monitor the development of call blocking technology and
act to ensure that the interests of the public as payphone users are adequately addressed. We
emphasize that our finding concerning the current limitations of call blocking technology only
restricts our ability to rely upon a carrier-pays system in which different payphones may charge
different compensation amounts, such as would be the case in the final phase of the
compensation mechanism established in the Commission's previous orders. As stated in those
orders, the adoption of a fixed default compensation amount, as we do in this Order, is designed
in part to address the existing technological limitations relating to call-blocking.
18. As of 30 days after publication of this Order in the Federal Register, IXCs must
compensate PSPs the default per-call compensation amount for all compensable payphone calls
not otherwise compensated pursuant to contract. For purposes of this Order, a compensable call
includes toll-free calls, access-code calls, certain 0+, and certain inmate calls. The default per-
call compensation amount shall be applicable through at least January 31, 2001. We anticipate
that, by this time, the parties will have had the opportunity to resolve the impediments that
currently inhibit the ability of payphone owners and carriers to negotiate fair compensation for
dial-around calls. If, by January 31, 2001, parties have not invested the time, capital, and effort
necessary to remove these technological impediments, or we determine that other impediments to
a market-based resolution continue to exist, the parties may petition the Commission regarding
the default compensation amount, related issues pursuant to technological advances, and the
expected resultant market changes. Barring an unforeseen change in the market or in the
relevant technology, we will look with disfavor upon any petition requesting that we modify,
before January 31, 2001, either the compensation amount or compensation mechanism. We find
that it will require a significant amount of time for IXCs to fully implement and deploy the
necessary technologies and that it is important to provide stability to the parties, the public, and
the market concerning the amount of per-call compensation.
II. BACKGROUND
19. Both the states and the Commission historically have regulated the payphone
industry. At the time of the Bell System break-up, payphones were considered part of basic
local telephone service, and thus, under the Modified Final Judgment, were assigned to the BOCs
rather than AT&T. Soon thereafter, technological advancements resulted in the deployment of
"smart" payphones that, through computerization, could perform much of the control and
supervision functions previously provided by the local exchange carrier. As a result of this
innovation, the Commission recognized that non-LEC providers should be allowed to
interconnect smart payphones with the local and interstate network. This resulted in the advent
of independent payphone providers competing with LECs in the provision of payphone
services. Payphones, like residential phones, typically have presubscribed long distance
carriers. In most instances, the presubscribed carrier compensates the PSP for the right to be the
0+ or presubscribed carrier. This compensation typically takes the form of a certain percentage
of the revenue derived from long distance traffic from the payphone.
20. Prior to the 1996 Act, the Commission's payphone regulation focused primarily
on carriers known as operator service providers (OSPs) that provided operator-assisted long
distance service. Specifically, these efforts concerned the implementation of the TOCSIA. In
order to allow consumers to choose their long distance carrier, the Commission implemented
additional regulations pursuant to TOCSIA. Under these regulations, a PSP may not prevent
consumers from dialing around the PSP's presubscribed operator service provider in order to
access their preferred carrier. Thus, under TOCSIA, PSPs may not bar outgoing access calls.
21. Section 276(b)(1)(A) of the Act specifically directs the Commission to establish a
plan to ensure that PSPs are "fairly compensated" for every completed call on a per-call basis.
The 1996 Act does not prescribe a particular method for achieving these goals, other than to
specify that such action shall "promote competition among payphone service providers and
promote the widespread deployment of payphone services to the benefit of the general
public[.]"
22. The Commission determined in the First Report and Order that the primary
economic beneficiaries of access-code and toll-free subscriber calls, the IXCs, should be
responsible for compensating the PSPs. The Commission determined that because of section
226's prohibition against PSPs barring access calls to IXCs, PSPs were deprived of market
leverage to negotiate fair compensation for the delivery of such calls to IXCs. The
Commission, therefore, established a default per-call compensation amount to be paid by IXCs to
PSPs, in the absence of individual agreements.
23. The Commission concluded in the First Report and Order that use of a purely
incremental or marginal cost standard for all calls would be inadequate, because PSPs would be
unable to recover a reasonable share of the joint and common costs of the payphone. The
Commission further determined that, because the payphone market has low entry and exit
barriers and likely would become increasingly competitive, the Commission should choose a
market-based, rather than a cost-based, methodology to establish a default compensation
amount. In setting a default compensation amount, the Commission noted that, over the long
term, the payphone market generally will be best equipped to set the appropriate price for
payphone calls. The Commission found that, ultimately, the appropriate per-call compensation
amount for compensable calls, in the absence of a negotiated agreement, will be the amount a
particular PSP charges for local coin calls. The Commission based this conclusion on its belief
that the market eventually will determine the fair compensation amount for local coin calls.
Because fully competitive conditions did not exist, however, the Commission established an
interim compensation plan that would be in effect for two years, after which the market would
set the amount.
24. In establishing an interim default compensation plan for toll-free and access-code
calls, the Commission chose a surrogate market price of $.35 per call, which was the local coin
call price in several states where payphone call prices had been deregulated. In making its
selection, the Commission concluded that the costs of coin calls and dial-around calls were
"similar."
25. On appeal, the Court concluded that the Commission had not adequately justified
its conclusion that the costs of local coin calls are similar to those of toll-free and access-code
calls, and remanded the matter to the Commission. The Court found evidence in the record that
the costs of coin calls exceeded the costs of coinless calls, due to: (1) the equipment and coin-
collection costs associated only with coin calls; and (2) the PSP's responsibility to pay for
originating and terminating local coin calls, while being responsible for paying only for
originating coinless calls.
26. In the Second Report and Order, the Commission responded to the Court's
remand. The Commission affirmed its decision in the First Report and Order to use a market-
based, interim compensation amount for compensable calls. The Commission explained that it
found no statement in the Court's decision that would preclude the Commission from relying on
market-based surrogates in establishing the per-call compensation amount. The Commission
instead determined that the Court remanded portions of the Second Report and Order so that the
Commission could more sufficiently address information on the record regarding cost disparities
between the cost of providing coin calls and the cost of providing toll-free and access-code calls.
27. Responding to the Court's findings, the Commission concluded that the
appropriate per-call compensation amount for dial-around calls was the market-based local coin
price, adjusted for the differences in costs between providing coin calls and compensable calls.
The Commission examined the underlying cost components and found that the cost to PSPs of
providing compensable calls was $.066 less than the cost of providing coin calls. Based on this
finding, the Commission determined that the market coin call price of $.35 should be reduced
$.066 to arrive at a default per-call compensation amount of $.284. The Commission
concluded that this default amount would be in effect for two years, until October 6, 1999.
After two years, the per-call default amount would be the market-based local coin price, less
$.066, representing the net avoided costs of a dial-around call.
28. On appeal, the Court remanded portions of the Second Report and Order. The
Court held that the Commission did not adequately justify the derivation of a compensation
amount for coinless payphone calls. In particular, the Court held that the Commission failed to
explain why a market-based compensation amount for coinless calls could be derived by
subtracting avoided costs from a market price charged for coin calls. By public notice released
June 19, 1998, the Commission sought comment on the issues remanded by the Court. In
addition, several parties filed petitions for reconsideration of the Second Report and Order.
III. THE ECONOMICS OF PAYPHONE TELEPHONY
29. In order to explain more clearly our reasons for adopting the compensation
methodology we do in this order, we briefly summarize here our understanding of the cost
structure of payphones, the nature of competition among payphones, and the problems associated
with designing a mechanism for allocating the common costs of payphones.
A. Payphone Costs and Revenues.
30. Payphones offer access to a number of different services, including local coin
calls, dial-around calls to access a user's preferred long distance company or a toll-free subscriber
such as 1-800-FLOWERS, and long distance calls using a particular payphone's presubscribed
IXC. For purposes of this discussion, we focus primarily on local coin calls and dial-around and
toll-free subscriber calls. We generally will refer to the latter two types of calls as "dial-around
or compensable calls."
31. The vast majority of the costs of providing payphone service are fixed costs that
are common (also referred to as "joint and common") to the provision of all payphone services.
These fixed common costs include the capital cost of buying and installing a payphone in a
particular location and certain monthly recurring costs, such as the cost of leasing the local line
and monthly maintenance and overhead costs, also known as sales, general, and administrative
(SG&A) costs. In addition, there are certain additional incremental costs to the payphone
provider associated with the provision of coin calls. These incremental coin costs include
certain fixed costs, such as the cost of the coin box, and certain variable costs, such as any
termination charges for local coin calls and the costs of collecting the coins from the
payphone. In contrast to coin calls, the incremental cost of a dial-around or compensable call is
virtually zero. This is because the payphone provider is only providing access to the IXC, and
the IXC pays any costs associated with transporting and terminating a call to a called party. The
fact that payphone service consists of relatively high fixed costs and low or zero marginal costs is
important in understanding the nature of competition among payphones.
32. The revenue a payphone generates depends upon the volume of each type of call
made from the payphone and the price of those calls. Thus, if the number of calls is held
constant, an increase in the price for a particular type of call will increase the revenue of the
payphone. Similarly, holding the price constant, an increase in the number of calls at a payphone
will increase the payphone's revenue.
33. The profit from a payphone is simply the revenue it generates, less the costs
associated with the payphone. Because payphones have significant fixed costs that must be
recovered, the price for each type of payphone call must exceed the marginal cost of the call if
the payphone is to earn a normal rate of return. Stated another way, if every call is priced at the
marginal cost of that call, the payphone would be unprofitable, because it would fail to recover
the predominant fixed costs of providing the payphone. Because the price for each type of call
must exceed its marginal cost, it is also clear that an increase in the number of any type of call
will increase the payphone's profitability by contributing either to the recovery of the payphone's
fixed cost or to the payphone's profitability.
B. Competition Among Payphones.
34. To explain the nature of competition in the payphone market, we begin by
assuming that payphones can only provide coin calls. In this case, a PSP will install a payphone
only if it believes that the demand for coin calls will be sufficient for it to earn at least a normal
rate of return. A highly profitable payphone typically attracts the entry of additional
payphones. The resulting competition should reduce the number of calls each payphone
receives and possibly reduce the price. The reduction in the number of calls and any reduction in
price will reduce the incumbent payphone's profits. Economic theory suggests that entry will
continue to occur until the last entrant earns just a normal rate of return. If we assume that
demand for payphone calls is uniform in a particular area and that all payphones are equally
efficient, we would expect that entry of new payphones into the area would continue until all
payphones earn just a normal return and no supranormal profits. Moreover, because of the high
fixed costs of a payphone, we would expect the price for each coin call to exceed its marginal
cost in order for a PSP to recoup its fixed costs.
35. Now, let us add to this analysis the ability of coin payphones also to provide dial-
around or compensable calls and the assumption that the payphone is required to charge a set,
per-call compensation amount for each dial-around or compensable call. As long as this per-call
compensation amount exceeds the marginal cost of providing a dial-around call, we would
expect existing payphones to start earning a profit. As stated in the previous paragraph, this
profitability will attract more payphone entry and increase the number of payphones in the
market. Maintaining our assumptions of uniform demand and equally efficient payphones, we
would expect entry to continue until all payphones are just breaking even.
36. This theory is complicated, however, by the diversity of the payphone market.
First, demand varies greatly among locations. Not only does the number of calls (i.e., quantity of
demand) for particular payphone services vary from location to location, but also the elasticity of
demand for particular payphone services may vary. Thus, for example, if we compared a
payphone at a busy bus station with a payphone at a corner grocery, we might expect that the bus
station payphone would generate a larger total volume of calls and that a higher percentage of
those calls would be dial-around calls, compared to the payphone at the local grocery. Where
demand is greater than average, it is possible that some payphones might generate a greater than
average number of calls and thus positive profits. This might occur in areas where it is not
possible for another competing payphone to enter profitably. If this were the case, it is possible
for the first payphone to continue to earn positive profits.
37. A second important characteristic of the payphone market is that many of the
payphone locations are controlled by owners that can limit the entry of competing payphones.
For example, the owner of a busy bus station can limit the number of payphones placed on its
property. In such cases, we would not expect entry to reduce the number of calls per payphone
(or the price) to the point where each payphone is earning only a normal rate of return. Rather,
we would expect the location owner to attempt to limit entry to increase the profitability of
payphones and then demand at least a share of the profits in the form of a location rent. This
phenomenon is frequently described as a "locational monopoly" that generates location rents.
Where demand is higher than average, and the premises owner can limit entry, it is possible that
some payphones would generate a higher-than-average number of calls, and thus positive profits.
If this were the case, those payphones could continue to earn positive profits. This profit would
be split between the owner of the locational monopoly and the payphone provider. Since the
owner of a locational monopoly can choose between multiple possible payphone providers, we
would generally expect the owner of the locational monopoly to capture the bulk of this profit.
38. While not perfectly competitive (since some payphones are earning positive
profits), this payphone market may still be characterized as workably competitive. It is
important to recognize that, where different locations have different levels of demand, some
payphones will be more profitable than others. Moreover, no level of regulation (except possibly
confiscatory taxation) could eliminate these profits. Thus, the existence of some payphones that
earn positive profits does not mean that the market necessarily should be regulated. It is also
worth noting that, where demand varies among locations, unregulated coin rates may, but need
not, vary. Most importantly for purposes of this Order, no per-call method of payphone
compensation could eliminate these profits, because that would require creating a unique price
for each and every payphone. Indeed, those payphones that are profitable without dial-around
calls would still be profitable with a zero price for dial-around calls.
39. In summary, we offer the following observations. First, the cost structure of
payphones and the nature of payphone competition suggests that competition will occur
primarily through the entry of new payphones (though possibly also through competing
reductions in price), which will reduce the number of calls at each payphone (or per-call
margin) until the new entrants are just earning normal rates of return. Second, because of the
fixed cost of a payphone, the price for each type of payphone call will exceed its marginal cost,
even for payphones that are just earning a normal return. Third, because of variations in demand
and locational monopolies, we should expect that a significant number of payphones receive
larger volumes of calls than a payphone in a marginal location that is earning a normal rate of
return. Thus, those payphones with high call volumes will earn positive profits, regardless of the
level of compensation for dial-around calls. Fourth, we note that a payphone owner will never
install a payphone unless it believes that the payphone will at least earn a normal rate of return.
Thus, absent regulations that require payphone owners to place phones in locations where they
will lose money, we should not expect to see money-losing payphones that offset the profits
earned on profitable payphones. Fifth, we observe that because the marginal cost of dial-around
calls is virtually zero, any compensation amount will represent some contribution to common
fixed costs or profit. Moreover, any dial-around compensation amount both will enable certain
marginal payphones just to break even, and contribute positive profits to already profitable
payphones. In fact, even if the compensation amount were set at zero, many payphones would
earn a profit. Finally, we note that any increase in the compensation amount will not only reduce
the break-even number of calls and thus increase the number of payphones, but also increase the
profits generated by payphones that are already profitable, (i.e., inframarginal).
C. Possible Market Failures Relating to Dial-Around Compensation.
40. When the Commission deregulated the price of local coin calls in the First Report
and Order, it based its decision, at least in part, on the low barriers to entry and exit in the
payphone market and the ability of customers at a particular payphone to either use another
payphone or decline to make the call if the coin price was deemed too high. These factors,
along with the experience of states that had deregulated the price of local coin calls at payphones,
persuaded the Commission that it could rely on competition in the market for payphones to
constrain the price of these calls. We also note that, since the adoption of the First Report and
Order, a number of state commissions have concluded that the market for payphone service is
competitive.
41. The Commission at that time, however, was unwilling to deregulate immediately
compensation for dial-around calls. We continue to believe that it is not yet possible to
immediately deregulate the price for dial-around calls. One reason for this is that, under current
arrangements, the party receiving the call is unable to ascertain the price that the payphone
provider is charging for the call and thus to make an informed decision on whether to accept the
call. That is, technology is not currently deployed for IXCs or toll-free subscribers to selectively
block calls based on the price that the PSP is charging them. An IXC or toll-free subscriber must
simply elect to accept all such calls from payphones or none. Therefore, under current
circumstances, a market cannot exist because the person paying the price is not able to decide
whether or not to purchase the call based on the price that is charged.
42. One possible way around this problem would be to switch to a caller-pays system
where callers are required to insert coins (or to use a credit card) to place dial around or toll-free
calls. However, as explained in the Commission's prior orders, and again below, this approach
appears to contradict congressional directives set forth in other sections of the Act.
Furthermore, a caller-pays system would impose significant extra transactions costs on payphone
users because they would have to either insert coins or enter another credit card number in order
to make these types of calls. Therefore, it is not clear that a caller-pays system would either be
legal under current statutes or desirable.
43. Another more promising solution to this problem would be for IXCs to develop
the technological capability to selectively block dial-around calls. That is, the IXC or toll-free
subscriber would need the capability to know the price that a payphone provider was
charging for a call, and be able to refuse to accept calls above a specified price. It is not yet clear
when IXCs will be able to deploy such technology or what such deployment would cost.
Therefore, it would not be prudent at this point to announce a firm date at which deregulation
might occur based on the assumption that this technology will exist at that time. We are
cognizant that problems other than the lack of targeted call blocking technology must be resolved
before we can move to a purely market-based mechanism. These additional problems will need
to be resolved before such a move. The existence of these additional impediments, however,
does not diminish the importance of targeted call blocking technology as a critical element to any
such move.
44. A related point concerns the final phase of the scheme established in the
Commission's previous orders, in which the default price for dial-around calls at any particular
payphone was based upon the price of a coin call at that particular payphone. In these orders, the
Commission did not explicitly consider whether or not such an arrangement might create
incentives for a payphone provider to raise its coin rate in order to be allowed to raise its dial-
around compensation amount. It may be, however, that in the absence of targeted call blocking,
tying the default compensation amount to the local coin rate may, in some instances, create an
incentive to raise the price of dial-around calls. this is so because the IXC could not respond by
selectively refusing to accept calls from that payphone.
D. The Common Cost Allocation Problem.
45. Regulators have long recognized that there is no single correct method for
allocating common costs among regulated services. Except for the general rule that regulated
services should not cross-subsidize each other, economic theory provides no guidelines as to
how common costs should be allocated. In the absence of such guidance, regulators have
generally adopted various fully-distributed cost (FDC) allocators. For example, if the common
input were used to produce two separate, regulated services, one simple rule would be to split the
common cost equally between the two services. An alternative rule would be to allocate the
common cost in proportion to the incremental cost or investment of the two services. In many
cases, regulators have allocated costs on the basis of relative usage. Another approach would
be to use Ramsey's-style pricing, which allocates the costs of the firm to the products based on
the products' relative marginal cost of production and price elasticities.
46. These alternatives demonstrate that there is no single correct way for allocating
the common costs of payphones. In fact, this difficulty is exacerbated by two additional factors
arising in the payphone context that regulators normally do not confront. First,
telecommunications regulators are usually asked to allocate the common costs of a network of
relatively fixed size designed to serve a relatively fixed number of people. Some parts of the
network are unprofitable, and others are profitable. In this scenario, the regulator can choose a
price for the regulated company's product such that the regulated company earns a regulated rate
of return, accounting for the range of profitability within the individual units. In other words,
where there is a range of profitability, and where entry and exit are very difficult, the regulator
may set a single price that offsets less-profitable units with the very profitable units. In contrast,
PSPs are free to enter the market where it is profitable and to exit where it is not. Thus, we are
unable to set a price that accounts for the range of profitability.
47. A second complicating factor is that section 276 of the Act mandates a structure
for recovering payphone costs, i.e., per-call compensation, that does not reflect the manner in
which most costs are incurred by payphone owners. As previously indicated, most common
costs of payphones are fixed -- that is, they do not vary with the volume of calls. Section 276,
however, requires that PSPs be compensated on a per-call basis. Because a per-call
compensation mechanism is traffic-sensitive, in order to assure that the fixed costs are covered at
a low traffic area, a fixed per-call compensation amount necessarily results in over-recovery of
common costs for payphones in high traffic locations. It is this requirement of a per-call
compensation mechanism that increases the profits at the payphones that are already profitable,
as discussed above.
IV. DISCUSSION
A. Remand Issues.
48. In this section, we respond to the Court's remand of the Commission's Second
Report and Order. We explain our basis for deciding on the appropriate compensation
methodology, in light of the statutory requirements of the Act, the underlying economic structure
of payphone telephony, current technological constraints, and the Court's findings in MCI v.
FCC.
49. We first define the scope of our compensation methodology by specifically
identifying the calls that are compensable under our rules. We then explain the factors that guide
our selection of a compensation methodology. Specifically, we define, for purposes of this
Order, "fair compensation" in terms of the economic constructs of payphone telephony.
Applying our definition of fair compensation within the confines of the Act's directives and the
Court's findings in MCI v. FCC, we decline to adopt, for now, a top-down methodology to
calculate the default compensation amount that uses the deregulated local coin rate as the starting
point.
50. We then explain our return to the Commission's initial view that a bottom-up
methodology should be used to establish a default compensation amount. We explain our
finding that a bottom-up methodology is currently the most equitable means of ensuring fair
compensation for PSPs in light of the very real statutory, technological, and economic constraints
within which we must make our decision. We emphasize again that our preference would be to
rely on a fully deregulated solution for setting compensation for coinless payphone calls. As we
explain, however, we conclude that there is no such solution available to us that is workable at
this time. Accordingly, we examine the most appropriate methodology for calculating the cost of
providing the service. We conclude that a bottom-up cost calculation is most reliable in light of
the Court's concerns in MCI v. FCC and our reexamination of the manner in which PSPs allocate
joint and common costs between local coin calls and compensable calls. Finally, we set forth the
manner in which we apply our bottom-up approach to establish a fair default compensation
amount.
1. Definition of Compensable Call.
51. As an initial matter, we specify the types of calls for which PSPs may receive the
default per-call compensation amount that we establish in this Order. "Compensable calls" for
purposes of this Order are calls from payphones for which the payphone owner cannot receive
compensation from another source.
52. Section 276 specifically provides that PSPs are not entitled to compensation for
911 emergency and TRS calls. Consequently, when entering the payphone business, PSPs
assume the legal obligation of allowing 911 emergency and TRS calls to be made from their
payphones without receiving per-call compensation. The term "compensable call" applies, as
does this rulemaking proceeding, to intrastate as well as interstate calls, by virtue of specific
provisions of section 276(b)(1)(A).
53. Specifically, we establish for purposes of this Order that the term "compensable
call" includes: (1) access-code calls; (2) toll-free calls; (3) certain 0+ calls (e.g., 0+ calls made
from a payphone where the PSP serve as an aggregator); (4) certain 0- calls (e.g., 0- calls in
states that, with FCC permission, prohibit blocking of such calls); (5) certain inmate calls (to
be specifically addressed in a separate proceeding); and (6) certain toll-free Government
Emergency Telecommunications Systems (GETS) 710 calls. "Compensable calls," in the
context of this Order, do not include: (1) coin calls or other calls, such as directory assistance
calls, for which the payphone provider can otherwise charge; (2) presubscribed 0+ calls; and (3)
0- calls in states that do not prohibit blocking of 0- calls. We reiterate that, for purposes of this
Order, calls that receive compensation from some other source, e.g., as part of an individual
contract between a PSP and an IXC, are not entitled to per-call compensation under this Order.
2. Definition of Fair Compensation.
54. In relevant part, section 276(b)(1)(A) requires that PSPs be "fairly compensated
for each and every completed . . . call." Neither the statute nor the legislative history makes
clear, however, what Congress meant by the phrase "fairly compensated." At the same time,
section 276(b)(1) directs the Commission to achieve this goal in a manner that will "promote
competition among PSPs and promote the widespread deployment of payphone services to the
benefit of the general public." The legislative history again provides little guidance. It would
appear, however, that section 276 was enacted, in part, in recognition of the limitation on the
ability of PSPs and carriers to negotiate a mutually agreeable amount as a result of TOCSIA's
prohibition on barring IXC-access calls by PSPs.
55. In light of the above, we find that PSPs will be fairly compensated if, at a
minimum, we: (1) balance the interest of PSPs and those parties that will ultimately pay the
default compensation amount; and (2) ensure that the default compensation amount is sufficient
to support the continued widespread availability of payphones for use by consumers.
56. We recognize that, because most payphone costs are fixed and each type of call
has a relatively small marginal cost, a wide range of compensation amounts may be considered
"fair." As we discussed above, the vast majority of the costs of providing payphone service are
fixed and common costs, and there is no one economically correct way to allocate such costs
among the different types of calls that may be made from a payphone. Economic theory does
suggest, however, that the costs of one service should not be cross-subsidized by another service.
That is, consumers making one type of call, such as a local coin call, should not pay a higher
amount to subsidize consumers that make other types of calls, such as dial-around or toll-free
calls. In order to avoid a cross-subsidy between two such services that are provided over a
common facility, each service must recover at least its incremental cost, and neither service
should recover more than its stand-alone cost. Within these parameters, many different
compensation amounts may be considered fair.
57. In its prior orders, the Commission defined "fair compensation" as the amount to
which a willing seller (i.e., PSP) and a willing buyer (i.e., customer, or IXC) would agree to pay
for the completion of a payphone call. In the Second Report and Order, the Commission, in
establishing a default compensation amount, found that fair compensation required that dial-
around calls contribute a proportionate share of the common costs of payphone service. We
continue to believe that this is an essential element of our determination of "fair compensation"
in this context. We find that any other approach would unfairly require one segment of
payphone users to disproportionately support the availability of payphones to the benefit of
another segment of payphone users. Such subsidies distort competition and appear inconsistent
with Congress's directive to eliminate other types of subsidies.
58. As we have also recognized in previous orders, the default compensation amount
will have a very real impact on the deployment of payphones. The default compensation
amount will not simply affect the total number of payphones, but also the deployment of
payphones in locations with comparatively lower volumes of traffic. MCI asserts that, in light of
the compensation amount of $.284, the increase in profitable locations will be minimal, but the
increase in profits at existing payphones will be large. While we agree with MCI that the effect
of $.284 amount could be significant for certain high volume payphones, we believe MCI's
concern is addressed in large measure by our reduction in the dial-around amount from $.284 to
$.24 per call. Moreover, and perhaps more importantly, the statute requires us to develop a per-
call compensation plan. The default compensation amount that we establish below seeks to
ensure that the current number of payphones is maintained.
59. In light of the above considerations, we conclude that the default per-call
compensation amount we establish should ensure that each call at a marginal payphone
location recovers the marginal cost of that call plus a proportionate share of the joint and
common costs of providing the payphone. We find such an approach satisfies the first condition
set forth above of providing a per-call amount that is fair to both payphone owners and the
beneficiaries of these calls (e.g., IXCs and toll-free subscribers). We believe that the $.24
compensation amount is fair, because it will allow PSPs to recover more than the marginal cost
of providing payphone service for dial-around calls and thus contribute to the common costs of
the payphone. We also find that basing this calculation on the marginal payphone location
satisfies Congress's directive that we ensure the widespread deployment of payphones. As
opposed to a calculation based on the average payphone location, use of a marginal payphone
location should promote the continued existence of the vast majority of payphones. Thus,
payphone owners will benefit because they will receive the compensation necessary to profitably
provide service. Consumers and long distance carriers will benefit because payphones will
remain widespread, which will ensure that consumers have ready access to make payphone calls
using the long distance carrier of their choice.
3. Reconsideration of the Second Report and Order's Top-Down Methodology.
60. In this section, we explain the Second Report and Order's compensation
methodology that the Court remanded in MCI v. FCC and the manner in which the statutory
constraints associated with TOCSIA and technological constraints limiting the availability of
targeted call blocking affect the viability of such a compensation methodology. In light of
these constraints, and mindful of the Court's findings in MCI v. FCC, we find that a
compensation methodology based on the market rate for local coin calls currently will not ensure
fair compensation for coinless calls from payphones. Additionally, upon reconsideration, we
find that our prior assumption regarding recovery of joint and common costs was incorrect. This
incorrect assumption undermines an important basis for a top-down methodology for
determining the cost to PSPs of providing coinless calls, because such a methodology assigns an
equal proportion of joint and common costs to both types of calls. Therefore, upon
reconsideration, we conclude that a bottom-up approach is more appropriate than the top-down
approach adopted in the Commission's previous orders, in which the Commission set the
compensation amount for coinless calls from each payphone according to that payphone's
deregulated local coin call rate. Although we do not adopt a top-down approach for
calculating the compensation amount for coinless calls, we use a top-down calculation to test the
reasonableness of our bottom-up calculation.
61. In the Second Report and Order, the Commission established a two-phase
compensation system. Under the first phase, PSPs would receive, for a two-year period ending
in October 1999, a default compensation amount of $.284 for each compensable call, absent an
agreement between the PSP and IXC on a different rate. The Commission arrived at this figure
by using a top-down approach for determining the costs to the PSP of making available coinless
calls from their payphone. The Commission's top-down approach started with what the
Commission determined was the most prevalent price of a deregulated local coin call (i.e., $.35).
From this starting point, and consistent with the Commission's understanding of the Court's
statements in Illinois Public Telecomm., the Commission subtracted the costs of providing coin
calls that are not incurred for providing coinless calls, an amount calculated to be $.066. Thus,
for two years, an IXC would be required to pay the PSP $.284 for every compensable call.
62. The Second Report and Order required that, after October 1999, compensation for
dial-around calls would be established by subtracting the net avoided costs of the dial-around call
($.066) from the deregulated local coin price charged by each payphone. Thus, under the
second phase of the compensation system, compensation to PSPs for compensable calls would
vary in relation to the local coin call price of the payphone being used.
63. In MCI v. FCC, the Court concluded that the Commission failed to adequately
explain the underlying premise for the top-down approach in setting a default compensation
amount. Specifically, the Court found that the Commission did not explain "why a market-based
rate for coinless calls could be derived by subtracting costs from a rate charged for coin calls."
The Court found that if "costs and rates depend on different factors, as they sometimes do, then
[the Commission's] procedure would resemble subtracting apples from oranges." The Court
posited that the Commission's conclusion might have depended on the premise that the market
rate for coin calls generally reflects the cost of coin calls. Although the Court reasoned that such
a premise could hold true in a competitive market in which costs and rates converge, the Court
found that the Commission failed to explain its reliance on such a premise. The Court also cited
the Commission's First Report and Order, in which, according to the Court, the Commission
acknowledged that the coin call rate might potentially diverge from the cost of coin calls.
Based on the finding that the Commission failed to adequately explain why the market-based
method did not equate to "subtracting apples from oranges," the Court remanded the matter to the
Commission.
a. TOCSIA and Targeted Call Blocking.
64. Because of TOCSIA and the present lack of targeted call blocking, we conclude
that the compensation system established in the Second Report and Order is currently
unworkable. First, under TOCSIA, the PSP (or seller) must connect (or sell) all calls to the
IXC. Under the Commission's prior approach, and after the two-year phase-in period, each
PSP would be allowed to set the price for compensable calls at whatever level it chose by raising
or lowering the local coin rate at a particular payphone. Accordingly, the PSP would be able to
receive a greater compensation amount by raising the local coin price. At a minimum, this
relationship creates a non-cost based incentive on the part of the PSPs to raise the local coin rate
from a payphone, not to make more money from coin calls but to increase the level of
compensation from dial-around calls. In most instances, we believe that the ability of a PSP to
raise its local rate in this manner will be constrained by competitive forces. As the Court pointed
out, however, we also have previously recognized that locational monopolies allow PSPs to set
some payphones' rates above cost. Additionally, where a payphone generates few local coin calls
relative to the number of coinless calls, e.g., a payphone located in an airport, linking the coinless
rate to the coin rate potentially could create instances where a PSP seeks to maximize its total
revenue by raising the local coin rate, even if doing so deterred customers from making coin
calls. In this situation, a PSP may be able to more than offset lost revenues from local coin calls
with the compensation it would receive from coinless calls.
65. Second, because the IXCs' current call-blocking technology only allows for an all-
or-nothing approach to blocking dial-around calls from a payphone, the IXC (or buyer) is unable
to choose whether or not to accept (or buy) a particular call. In other words, the IXC must either
buy every call from every payphone, regardless of the amount it must compensate the PSP for
the calls, or buy no payphone calls at all. In this scenario -- where the seller must sell and the
buyer must buy every call or none at all -- market forces are rendered ineffective as a means of
achieving an efficient price. We therefore conclude that a default compensation amount that
varies according to the deregulated local coin price does not ensure a fair compensation level,
unless carriers have some ability to reject a call based upon the compensation amount for that
call. Parties contend that such call blocking technology presently is not readily available in the
network and will take some time for carriers to implement.
66. In providing for a default compensation amount that was allowed to vary
according to the deregulated local coin price, the Commission stated that, under deregulation,
competitive pressures would constrain the amount PSPs could charge consumers for such calls.
Similarly, in an unrestricted market where IXCs compensate payphone owners based on an
amount that varies according to the local coin price, IXCs ideally should be able to decline calls
from payphones they believe to be excessively priced. Without targeted call blocking, however,
IXCs cannot do this. All-or-nothing call blocking may provide some downward pressure on high
dial-around prices charged by PSPs, but it is insufficient to reach a wholly competitive outcome
under the circumstances surrounding the Commission's previous compensation mechanism.
67. We note that the lack of targeted call blocking is a temporary phenomenon. The
overwhelming majority of payphones are, or soon will be, on payphone lines that transmit the
appropriate coding digits, as required in the Commission's prior orders in this proceeding.
Therefore, the ability to develop targeted call blocking technology rests largely with the IXCs.
We strongly encourage the IXCs to develop targeted call blocking. Targeted call blocking is an
essential element to an IXC's ability to negotiate with PSPs in a true market setting.
68. As we stated above, we are aware that targeted call blocking is not the only
problem that must be resolved in order to move to a deregulated resolution. Targeted call
blocking is, however, a critical element to real-time, wide-spread negotiations between payphone
owners and carriers. It is the threat that a PSP may have its dial-around calls blocked that
brings PSPs and IXCs into equal bargaining positions. Because it is in the interests of both the
PSP and the IXC to negotiate a mutually acceptable compensation amount, we do not desire, no
do we foresee the need for, the widespread use of targeted call blocking once the technology is
implemented and deployed. We also note that, although the default compensation amount that
we establish in this Order is reasonable and fair to all parties, an IXC that finds the default
compensation amount to be excessive may help remedy that situation by developing targeted call
blocking capability.
b. Recovery of Joint and Common Costs.
69. In establishing a compensation amount based on the price of a local call, the
Commission in the Second Report and Order sought to equalize the contribution that each call
made to the joint and common costs of each call. In adopting a top-down derivation of the
coinless default compensation amount based on the price of a local coin call, the Commission
assumed that PSPs set prices so that each type of call contributes an equal amount to joint and
common costs. Upon reconsideration, and based upon the additional information in the record,
we reassess the Commission's prior assumption regarding recovery of joint and common costs,
finding that our assumption is not necessarily valid. This reassessment undermines an important
basis for the Commission's top-down methodology.
70. We find insufficient evidence in the record to ascertain the method by which PSPs
set prices for a various types of calls in order to recover the common costs of providing
payphone service. The error in the Commission's assumption that each call contributes equally
to joint and common costs may be demonstrated by examining the revenue that PSPs receive for
0+ and 1+ calls. Although coinless calls (such as 0+ calls) cost less than coin calls, some PSPs
receive more than $.70 per 0+ call. This is more than twice as much as the prevailing $.35
local coin price. Also, the RBOC Coalition states that for many payphones, the 1+ sent-paid
charges (i.e., the coin price for a long distance call) exceeds basic long distance charges by an
average of $1.45 per call. Clearly, some PSPs do not price their calls such that each call makes
an equal contribution to joint and common costs. Therefore, if our goal is to price dial-around
calls such that they make a proportionate contribution to joint and common costs, we cannot do
so by basing their price on the local coin calling price, because we do not know how individual
PSPs price local coin calls in relation to the recovery of joint and common costs. Therefore,
upon reconsideration, we find unreliable the assumption that PSPs set prices so that each call
recovers an equal amount of joint and common costs.
c. MCI v. FCC.
71. Finally, in light of the Court's concerns regarding whether a market-based rate for
coinless calls could be derived by subtracting costs from a rate charged for coin calls, we find
that a top-down approach is unsuitable at present for setting default compensation. By using a
bottom-up approach, we resolve the Court's concerns, because we focus on the costs of a dial-
around call, rather than attempting to compare the rate and costs of a local coin call to the cost of
a dial-around call. The Court's concerns in MCI v. FCC and the other factors discussed in this
section persuade us that, at this time, a bottom-up compensation methodology is more
appropriate than a top-down methodology.
5. Selection of a Bottom-Up Methodology.
72. In light of existing technological, statutory, and economic constraints, we find that
the most appropriate mechanism for establishing fair compensation is a bottom-up approach. We
recognize that such a compensation mechanism does not replicate the price that the market would
set for each and every call from a payphone, which, in an ideal setting, would be our preferred
outcome. Under the constraints detailed previously, however, we conclude that a bottom-up
approach will best comply with the statutory directive of ensuring the widespread deployment of
payphones in a manner that is consistent with our definition of fair compensation.
73. In establishing a bottom-up approach, we considered three standard economic
approaches to setting prices, in addition to our review of the top-down methodology used in the
Second Report and Order: (1) marginal cost pricing; (2) the RBOC Coalition's Ramsey's-style
pricing; and (3) fully distributed cost coverage. As explained in Section IV.B. below, we
find that a fully distributed cost-coverage approach best fulfills our statutory directives within the
economic, technological, and statutory constraints that currently exist. Specifically, we find that
a fully distributed cost-coverage approach that determines cost by working from the bottom up
will comport with statutory directives and satisfy the Court's concerns raised in MCI v. FCC.
Furthermore, we find that, in keeping with Commission precedent arising from our
implementation of the 1996 Act, payphone costs will be calculated on a forward-looking basis.
Thus, in setting a default compensation amount using a fully distributed cost-coverage approach
(our "bottom-up" methodology), we examine the costs of a new payphone operation installing
new payphones.
74. As explained above, we find that "fair compensation" means that the marginal
cost of compensable calls, plus an appropriate amount of the joint and common costs of the
payphone operation, will be recovered for each compensable call. We conclude that a bottom-
up methodology will provide fair compensation consistent with this standard. Thus, rather than
focusing on the cost of adding one additional payphone to an operation, we instead examine the
total costs of a payphone operation and distribute those costs across all of the payphones in that
operation. We find that this approach results in a compensation amount that is fair to both
payphone owners and the beneficiaries of these calls. We also conclude that establishing a
compensation amount that allows a PSP to recover its costs will promote the continued existence
of the vast majority of payphones presently deployed, thereby satisfying what we consider to be
Congress's primary directive that we ensure the widespread deployment of payphones.
75. In this Order, we consider a cost to be "joint and common" if the amount of the
cost does not vary with respect to the mixture of calls at the payphone. For example, the cost
of a payphone's enclosure does not change due to an increase in the number of coin calls relative
to coinless calls, or vice versa. We conclude, therefore, that the enclosure is a joint and common
cost, and we attribute the enclosure costs to all types of calls. We attribute costs that are not joint
and common to the type of call associated with that cost. For example, as the number of coin
calls from a payphone increases, the coin collection costs also will rise due to the higher
frequency of coin collection trips. We therefore attribute coin collection costs solely to coin
calls.
76. As discussed above, we find that the use of a bottom-up approach also resolves
the concern that PSPs do not necessarily price their various services such that each call recovers
an equal share of joint and common costs. In the Second Report and Order, the Commission's
goal was to set a compensation amount that would allow each call to recover its share of joint
and common costs. The top-down approach, which subtracted the avoided costs of a
compensable call from the price of the local coin call, assumed that each call would contribute
equally to the joint and common cost. As explained above, we find that this assumption is not
necessarily reliable, based on the manner in which PSPs price various calls. Under our
bottom-up approach, however, that problem no longer is at issue. Under the bottom-up
approach, we use the total monthly joint and common costs of the payphone operation and divide
these costs by the total monthly number of calls from a marginal payphone location. This results
in a per-call share of the joint and common costs. Thus, a bottom-up approach alleviates the
problem of how to ensure that each call has the opportunity to recover its share of joint and
common costs.
77. Our bottom-up approach also avoids the impact of the technological restrictions
discussed previously that undermine our previous approach of allowing the default rate to change
with the deregulated coin rate of each payphone. As explained above, in the bottom-up system
we adopt herein, we have set a single amount for compensation, which we find fair and
compensatory. IXCs do not need the ability to block calls from payphones based on a varying
compensation amount because all payphones will use the same compensation amount, absent an
agreement between the parties for some different level of compensation. Finally, our bottom-up
approach alleviates the Court's concerns in MCI v. FCC stemming from the Commission's use of
the local coin price as the starting point of compensation for dial-around calls. Under the
bottom-up approach, we do not use the local coin price to determine the costs associated with a
compensable call. Thus, we do not run afoul of the Court's concern that the Commission was
"subtracting apples from oranges." Rather, we determine each of the costs of the dial-around
call and add them together, from the bottom up, to determine the per-call compensation amount.
78. Our default compensation amount is calculated to allow the payphone owner the
opportunity to recover a proportionate share of joint and common costs associated with dial-
around calls. Payphone owners may, of course, determine that contracting with IXCs to receive
a lower amount will attract more dial-around traffic and thus increase their profits. Payphone
owners also have the opportunity to set their own prices for non-compensable calls, e.g., coin
calls and presubscribed calls, and may set the price for each type of call so that it covers the
marginal cost plus a proportionate share of joint and common costs. This would allow a
payphone in a marginal location the opportunity to recover all of its costs. Of course, a
payphone owner may dismiss this pricing strategy in favor of an alternative strategy that may
prove to be more profitable.
79. We note that our approach is not designed to make every payphone profitable.
Payphones with sufficiently low call volumes or sufficiently high costs will not be profitable,
regardless of the compensation amount we establish. We discuss in Section III.B.3.b. below
our selection of a marginal payphone location and our calculation of the number of calls from
that location, important components of our calculation of the compensation amount.
80. Certain petitioners argue that we should use a marginal cost pricing approach, in
which prices are set by considering the cost of producing one additional good. Others argue that
we should use a Ramsey's-style pricing approach. We find, for the reasons stated below, that
marginal cost pricing and the RBOC Coalition's Ramsey's-style pricing are ineffective in
complying with our statutory goals. As explained elsewhere, however, we conclude that basing
our determination of fair compensation on the marginal payphone is the approach most
consistent with the statutory directive of ensuring widespread deployment of payphones.
81. Specifically, we reject marginal cost pricing for the same reasons given by the
Commission in the First Report and Order and alluded to in Section III above. That is, a
purely incremental cost standard for dial-around calls would undercompensate PSPs for
dial-around calls, because it would prevent PSPs from recovering a reasonable share of joint and
common costs from those calls. Thus, the revenue that would have been received from these
calls would be subsidized by revenue from other types of calls, which, in and of itself,
contradicts Congress's directive to eliminate subsidies and also distorts competition. Our
bottom-up approach, however, adequately considers and accounts for the dial-around call's share
of the joint and common costs. In Section III.B.2.c. below, we reject the RBOC Coalition's
version of Ramsey's-style pricing, in part, because the pricing methodology is extremely
sensitive to small changes in input estimates. Furthermore, we find unreliable the input estimates
provided by the RBOC Coalition.
82. Several economists argue that a top-down approach like that used in previous
orders is superior to a bottom-up approach. Dr. Becker argues that a bottom-up approach would
approximate the actual pricing of payphone services only by chance and would result in an
economically inefficient provision of payphone services. Dr. Kahn states that the
determination of costs from the bottom up inevitably is more contentious and subject to "political
influence." Dr. Hausman contends that a bottom-up approach cannot incorporate all of the
market information, such as demand and cost conditions, and states that an average cost approach
would result in the elimination of marginal payphones with below-average call volumes or
above-average costs.
83. In response to Dr. Becker's critique, we recognize that a bottom-up method may
not reflect the compensation amount that the market would set for a particular payphone. That is
not our intention in this Order. Our goal is to provide a PSP with a payphone at a marginal
location an opportunity to recoup all of that payphone's costs. In the alternative, PSPs are free to
negotiate with IXCs to lower the compensation amount for dial-around calls, in an effort to
attract more callers. In adopting a bottom-up compensation methodology, we reconsider our
conclusions in the First Report and Order on Reconsideration and Second Report and Order that
reliance on cost studies to set the compensation rate may reduce the amount of revenue recovered
by PSPs and therefore may reduce the number of payphones deployed. As we state herein,
however, because payphone operations incur very large fixed costs and very low marginal costs,
allowing PSPs to recover only their marginal costs would be undercompensatory.
84. In response to Dr. Kahn's concerns regarding the contentiousness of a bottom-up
approach, we find that, when applied to dial-around calls, both top-down and bottom-up
approaches are subject to differences of opinion. Although the top-down approach contains
fewer cost estimates to consider compared to a bottom-up approach, other difficult elements are
associated with top-down pricing. For example, as identified by the Court in MCI v. FCC, under
a top-down approach, one must determine the correct starting price for the adjustments.
Moreover, we believe that the number of disputable aspects of a particular approach is not a
dispositive basis for choosing a pricing methodology. Finally, in response to Dr. Hausman's
concerns, we agree that our bottom-up methodology does not consider the interactions of demand
and cost. We explain in detail below our reasons for declining to adopt Dr. Hausman's
recommendation that we use the RBOC Coalition's version of Ramsey's-style pricing.
85. Although we could have attempted to price dial-around calls by equating the
percentage markups over marginal cost for each type of call, we decline to do so for two reasons.
First, it would assume that payphone operators price their other calls, such as 0+ and 0- calls, in
that manner. We find no credible evidence to conclude that they do. Second, the resulting
suggested price would be greatly affected by small changes in the marginal cost estimates.
Under this approach, the default price would be determined by taking one fraction -- the markup
of a local coin call divided by its marginal cost -- and setting it equal to another fraction -- the
markup of a dial-around call divided by its marginal cost. Since three of the four factors are
known quantities (i.e., the marginal cost of a coin call, the marginal cost of a dial-around call,
and the markup of a local coin call), the fourth factor (i.e., the markup for dial-around calls) can
be determined by selecting an amount that equalizes the two fractions. The price of the dial-
around call would then be the sum of its marginal cost and its newly determined markup.
Because the marginal costs of payphone calls are so small, however, if one of the marginal cost
estimates (such as the marginal cost of a coin call) changed by only a few cents, the amount of
the markup for dial-around calls equalizing the two fractions would change greatly. Because the
price of a dial-around call would be the sum of its marginal cost and its markup, the resulting
change in the markup would have a large effect on the price of a dial-around call.
86. In summary, we find that using a Ramsey's-style pricing mechanism leads to
highly varied prices, depending on the estimate of marginal costs and elasticities. We do not
believe that we can obtain sufficiently accurate marginal cost and elasticity estimates to use a
Ramsey's-style pricing mechanism. We note that the RBOC Coalition believes that its
Ramsey's-style pricing mechanism leads to a default compensation amount higher than $.35.
We show in Section IV.B.2.b. below, however, that in using estimates that we consider more
reasonable, the RBOC Coalition's Ramsey's-style pricing mechanism leads to a default price that
is less than the default price arrived at by using bottom-up approach we adopt in this Order. This
underscores our concern about the large variance resulting from minor changes in assumptions.
87. We decline to use marginal cost/demand considerations as a reason to choose top-
down pricing. There is no reason to believe that pricing compensable calls based on the market
price of local coin calls is superior to bottom-up pricing, because the price of local coin calls is
principally affected by the demand and marginal costs of coin calls, not coinless calls. This
would result in what the Court in MCI v. FCC refers to as "comparing apples to oranges." Any
attempt to modify the bottom-up default compensation amount in an effort to account for some
measure of the marginal cost/demand analysis would amount to a purely arbitrary adjustment,
because the size of an appropriate adjustment could not be quantified. Further, we find incorrect
the RBOC Coalition's contention that the dial-around price should be at least $.35, because, as
we show below in Section IV.B.2.b., reasonable marginal cost and elasticity estimates produce a
price less than our default price.
6. Conclusions and Response to the Court.
88. We conclude, for the reasons stated above and elsewhere in this Order, that a
bottom-up methodology is the most appropriate means for establishing a default compensation
amount at this time. We also conclude that our selection of a bottom-up methodology reasonably
resolves the Court's concerns, as expressed in MCI v. FCC. As the Court indicated, a market-
based rate may be an appropriate method at some point in the future. When the time is
appropriate, we will consider revisiting this issue.
C. Reconsideration Issues.
89. In this section, we address petitioners' arguments in support of, and in opposition
to, various methodologies for determining the default compensation amount. In addition to the
bottom-up methodology described above, we set the default compensation amount.
1. Overview
90. In the Second Report and Order, the Commission established an interim default
compensation amount for dial-around calls made from payphones by adjusting what the
Commission determined to be the current deregulated coin price of $.35 to account for cost
differences between coin calls and coinless calls. Thus, the Commission subtracted from $.35
costs directly attributable to coin calls and added costs directly attributable to dial-around or
compensable calls. In order to determine certain per-call costs, the Commission estimated the
number of monthly calls made from a payphone in a marginal location. Specifically, the
Commission deducted the following costs associated with coin calls from the deregulated local
coin price: avoided costs for the coin mechanism; local coin call termination charges; and coin
collection and maintenance costs. The Commission then added the following costs associated
with dial-around or compensable calls: expenses for coding digits and interest on delayed
receipts. The Commission declined to make adjustments to the price for bad debt, collection
costs relating to per-call compensation, opportunity costs, or location rents. These calculations
produced an adjusted market-based range for the cost of dial-around calls of $.277 to $.291.
The Commission established the interim default compensation amount at $.284, the midpoint of
this range. As explained previously, this was to be the fixed default compensation amount
until October 1999, after which the default compensation amount would vary with the local coin
price for each payphone, less avoided costs.
91. In response to the Second Report and Order, multiple parties filed petitions for
reconsideration. In addition to the record relating to these petitions, several parties filed
comments in response to our Public Notice, released subsequent to the Court's remand in MCI v.
FCC. Our resolution of the petitions for reconsideration is based on the record arising from
the reconsideration petitions, as well as the record created by the Public Notice.
92. The reconsideration petitions generally challenge two aspects of the Second
Report and Order: (1) the Commission's overall methodology in setting the default compensation
amount; and (2) the cost components underlying the Commission's calculation of the default
compensation amount. In this Order, we have selected a bottom-up methodology to establish a
default compensation amount for compensable calls. This decision renders moot, in large part,
petitioners' challenges to the Second Report and Order's methodology. Below, however, we
address petitioners' remaining arguments supporting and opposing various compensation
approaches.
93. As explained in Section IV.B.3. below, we establish a per-call default
compensation amount of $.24, using a bottom-up methodology that we adopt in this Order. We
set the default compensation amount by evaluating the component costs of a dial-around call.
Our evaluation incorporates our resolution of relevant arguments concerning the Second Report
and Order's cost components raised in petitions for reconsideration. In certain instances, our
evaluation includes adjustments that were not explicitly requested by petitioners, but were raised
by new evidence in the record.
2. Alternative Compensation Methodologies.
94. In this Section, we address alternative compensation mechanisms put forth by
commenters that were not discussed above in connection with the Court's remand.
a. Duration Methodology.
95. Several commenters argue that the compensation amount for a toll-free call
should be based on the duration of the call. PageMart asserts that most paging calls last less
than 30 seconds, while other dial-around calls last three to five minutes. PageMart suggests
that the cost of a toll-free call from a payphone varies according to duration, noting that "[s]ome
of the factors leading to higher costs for longer calls include (i) the potential for increased line
charges; (ii) wear and tear and added depreciation from extended use of payphone equipment;
(iii) opportunity costs incurred with extended use; and (iv) increased commissions in connection
with high usage payphones." Pocket Science contends that consumers would be better off if
dial-around compensation were based on the duration of the call, in part, because low-income
consumers could more easily afford access to electronic mail by using Pocket Science's
product. Specifically, Pocket Science maintains that the compensation amount should be
based on minutes of use and capped at $.285. Although the RBOC Coalition is not in favor of
basing dial-around compensation on the call's duration, one of its economists suggests that doing
so may be appropriate.
96. In contrast, APCC argues that, although "measured compensation may have some
theoretical appeal," it is impractical at this time, because payphone operators do not have the
ability to monitor the length of the call. Further, AT&T states that implementation of such a
system would: (1) cost millions of dollars; (2) require 12-18 months so that it could update its
systems; and (3) result in unnecessary administrative burdens.
97. We are not convinced by the record evidence that the marginal costs of a
relatively shorter dial-around call are significantly different than those of a longer call. Although
the line charge for some coin calls may vary depending on the length of the call, dial-around calls
do not incur any additional line charge, regardless of their length. Indeed, as we have
discussed, because most payphone costs are fixed, they do not vary with the length of the call.
Nor are we convinced that longer calls cause a significant amount of additional wear and tear on
a payphone. Consistent with the Commission's determination in the Second Report and Order,
we decline to make an adjustment for opportunity costs of a dial-around call because we
conclude that it is unlikely that the revenue from another call will be lost. In the Second Report
and Order, the Commission concluded that compensating PSPs for opportunity costs was not
necessary because the evidence demonstrates that dial-around calls only occupy 1.8 percent of
available payphone usage time. In this Order, we decline to consider location rents as a cost of
a dial-around call. Even if we were to consider including compensating PSPs in connection
with location rents, the amount of rent would not vary with the duration of a phone call because
the amount of payphone revenue would not change.
98. Furthermore, we are persuaded by APCC and AT&T that a duration-based
methodology would result in added expense, delay, and confusion. Several complaints have
already been filed with the Commission regarding payment of payphone compensation. We
believe the establishment of a duration-based methodology would result in the filing of even
more complaints, thereby exacerbating, rather than resolving, the current situation.
99. Contrary to Pocket Science's suggestion, even if we based the compensation
amount on the duration of a call, we could not cap the compensation amount at $.285 or any
other amount, because it would not fully compensate PSPs. Assuming the default amount were
set at $.285, PSPs receiving less than $.285 for short calls must receive more than $.285 for
longer calls in order for the PSP to be fully compensated. We therefore decline to alter the
payphone compensation mechanism to reflect the duration of the call. We note, however, that
IXCs and LECs are free to use measured service compensation in their contracts, if they so
choose.
b. RBOC Coalition's Ramsey's-Style Pricing Methodology.
100. In setting per-call compensation in the Second Report and Order, the Commission
declined to apply the RBOC Coalition's price-setting methodology using an analysis of the
comparative elasticities of demand associated with coin and dial-around calls, as advocated by
the RBOC Coalition. The RBOC Coalition sought to demonstrate that, in addition to
considering avoided costs in setting a market price, competitive firms consider a product's
elasticity of demand. The RBOC Coalition argued that elasticities in this case would result in
a market price for access calls of the coin rate plus $.07 to $.08, or a total of $.42 to $.43. The
Commission observed that there were wide variations in the record regarding the assumed
elasticities and concluded that the evidence was inadequate to determine the relative elasticities
of coin and coinless calls.
101. The RBOC Coalition argues that the Commission conceded in the Second Report
and Order that competitive firms consider demand elasticities in setting prices, but failed to
apply an elasticities analysis in this case. The RBOC Coalition contends that its method of
utilizing elasticities and marginal costs to set the price of toll-free and access-code calls from a
payphone is based on conservative estimates and empirical data. According to the RBOC
Coalition, consumer demand for dial-around calls is less elastic than consumer demand for coin
calls. Thus, APCC argues, if a PSP examined its elasticities and marginal costs, it would set the
price of a dial-around call higher than the price of a coin call. AT&T responds that there
cannot be cross-elasticities of demand between two products, such as coin and coinless calls, that
are in totally different markets.
102. We again decline to adopt the RBOC Coalition's elasticities methodology. Our
objection is not that elasticities and marginal costs cannot be taken into account in setting
product prices, especially in an industry with high fixed and common costs. Rather, we find that
we do not have sufficiently accurate information in the record to use elasticities and marginal
costs in this particular case. We also conclude that, for purposes of setting dial-around per-call
compensation, the RBOC Coalition's proffered methodology results in prices that are unreliable.
Specifically, the RBOC Coalition's methodology is highly sensitive to estimated values of
elasticities and marginal costs. In conjunction with the RBOC Coalition's highly speculative
estimates of the elasticities and marginal costs at issue, we find that the resulting "suggested
price" is widely variant and thus of little practical value in establishing a reasonable
compensation figure. Simply put, the RBOC Coalition's methodology gives wildly divergent
answers when the inputs are changed even slightly, and we find such variance unacceptable
given the unreliability of the information we have for input data.
103. The RBOC Coalition's proposal is a variation of a traditional economic theory
known as Ramsey's pricing. In the classic version of the theory, a regulator setting prices for a
hypothetical firm considers the elasticity of all of the products related by joint and common costs
and sets the prices simultaneously. Thus, when pricing, the regulator would set the prices for
all the related goods such that the markup ratio (markup divided by price) of the first good
divided by that good's price elasticity is equalized to the markup ratio of the second good divided
by the second good's price elasticity. The regulator also would set the prices so that the firm
earned only a normal rate of return.
104. The RBOC Coalition's methodology varies from the classic theory in several
respects. The RBOC Coalition's theory assumes that the price of a local coin call is fixed at the
price that was established before per-call compensation for dial-around calls was established.
We believe that the RBOC Coalition's failure to set all payphone prices simultaneously
undermines its application of the theory. In strictly applying Ramsey's pricing, payphone owners
would not consider the local coin call price as fixed when deciding how much to charge for other
types of calls. The problem with the RBOC Coalition's improper use of a fixed starting price
is compounded by the fact that the local coin call price is necessarily rounded to a nickel
increment.
105. Performed properly, moreover, Ramsey's pricing would price all types of
payphone calls distinctly. The RBOC Coalition's analysis, however, does not properly price
0+ calls distinctly. The RBOC Coalition implicitly assumes that 0+ calls have the same
elasticity as dial-around calls. We believe that the demand for 0+ services is much less elastic
than the demand for other coinless calling services. We therefore believe that the resulting
optimal price for dial-around calls would almost surely be lower than the price the RBOC
Coalition suggests. This is due to the RBOC Coalition's failure to take into account the excess
profitability resulting from the high-priced 0+ calls. We believe that 0+ calls (perhaps the least
price-elastic class of service provided by payphones) would have the highest markup. With
the increased revenue from dial-around and 0+ calls, payphones would become more profitable.
Increased profitability would lead to more payphone installations, and the increased number of
payphones would lead to a more elastic demand for the payphone in question. The payphone
operation would then lower its calling prices. Accordingly, we find the RBOC Coalition's failure
to treat 0+ calls distinctly, and its failure to account for the payphone's resulting profitability,
leads to an overestimate for the price of dial-around calls.
106. The RBOC Coalition's methodology also relies on speculative estimates of
elasticities and marginal costs for both coin calling and dial-around access. Although the RBOC
Coalition presented casual empirical evidence of local coin call elasticity, it did not present an
empirical estimate of the elasticity associated with dial-around calls. Instead, the RBOC
Coalition attempted to estimate the elasticity of dial-around calls by modifying the better-
estimated elasticity of interstate long distance toll calls. The RBOC Coalition states that this
estimate is conservative because many long distance access-code callers have higher-than-
average incomes, or are business callers, whose demand for access-code calls is less elastic than
for standard interstate long distance calls.
107. We find this reasoning speculative. We note that frequent users of dial-around
access have the incentive to acquire the most information about prices, terms, and conditions.
Their long-run demand, therefore, may be very elastic. Many payphone calls are international,
and the demand for international calls is much more elastic than domestic toll calls. The
RBOC Coalition estimated the blended elasticity for toll-free and access-code calls to be -.398.
Although the record does not contain any empirical estimates of the elasticity of dial-around
calls, our experience in this area leads us to conclude that the blended elasticity could plausibly
be as much as 50 percent higher, or -.6. We do not believe that -.6 is the correct value for the
blended elasticity of a dial-around call. Rather, we find that -.6 creates the elastic bound of the
true estimate. In other words, for the reasons stated above, we believe that the RBOC Coalition's
elasticity estimate of -.398 is the inelastic bound of the actual blended dial-around elasticity and
that -.6 is the elastic bound.
108. We also disagree with the marginal cost estimates provided by the RBOC
Coalition. First, the RBOC Coalition relies on an Arthur Andersen estimate of $.04 for the
marginal cost of a coin call, but gives no basis for the Arthur Andersen estimate. We have
estimated that, on average, the marginal cost of a coin call is $.053, and in some areas it may
be as high as $.127.
109. Additionally, the RBOC Coalition estimates that the marginal cost of a dial-
around call is $.05, based solely on FLEX ANI costs. We conclude that the per-call
marginal cost is less than $.01. First and foremost, FLEX ANI costs will not be marginal.
Among the LECs that have tariffed the cost recovery element for FLEX ANI costs, the charge is
a flat monthly rate element attached to all payphone lines. Because the charge does not vary with
the number of dial-around calls or any other type of call, it will not affect the marginal cost of a
dial-around call. Further, dial-around calls do not generate any additional line charges or coin
collection costs. Other types of costs associated with a payphone, such as maintenance, SG&A,
and capital costs, correlate to the number of payphones, but not to the number of dial-around
calls from a payphone. The record does not contain any quantifiable marginal costs to support
a specific estimate, and we conclude the marginal cost of these calls is less than $.01.
110. The most serious flaw in the RBOC Coalition's methodology is that it is highly
sensitive to the estimates of the very parameters that we find to be improperly estimated: the
elasticity of dial-around access, the marginal cost of a coin call, and the marginal cost of a
coinless call. We illustrate the vagaries of the RBOC Coalition's methodology in the following
table, which shows the "optimal" dial-around price suggested by the RBOC's pricing
methodology and the suggested price for the various permutations of marginal cost and elasticity
estimates. Although we conclude that the marginal cost of a dial-around call is virtually zero, for
purposes of examining the suggested price resulting from the RBOC Coalition's methodology,
we assume that the marginal cost of a dial-around call is $.01. Without this assumption, the
RBOC Coalition's methodology would result in a price of zero for dial-around calls. When
calculating the suggested dial-around price, we use the weighted average coin calling elasticity of
-.663, as reported by the RBOC Coalition.
111. The following table shows that the RBOC Coalition's suggested pricing
methodology results in dial-around calls being priced from $.07 to $1.59. The RBOC Coalition's
variant of Ramsey's pricing results in a range of optimal prices so wide that we conclude that it
cannot be used as a basis for selecting the default compensation amount for dial-around calls.
Further, the table shows that when using a more accurate (yet still a conservatively low)
marginal cost estimate of a coin call and a more accurate (yet still a conservatively high)
marginal cost estimate of a dial-around call, the suggested price of a dial-around call ranges from
$.07 to $.20. This demonstrates two points. First, when using the RBOC Coalition's Ramsey's-
style pricing for payphone calls, uncertainty about even one of the inputs (in this case, the
elasticity of dial-around calls) generates a range of prices that is much too wide to use. It also
demonstrates that taking into account demand and cost conditions leads to a lower price than our
default price of $.231 (before adjustment for interest). We therefore conclude that the RBOC
Coalition's Ramsey's-style pricing should not be used to set the default compensation amount,
and that the RBOC Coalition's methodology does not demonstrate that our methodology is
undercompensatory.
OPTIMAL (DEFAULT) PRICE FOR A DIAL-AROUND CALL USING
THE RBOC COALITION'S RAMSEY'S-STYLE PRICING METHODOLOGY
The Marginal Cost of a Dial-Around Call
$.01
$.05
If the marginal cost of a coin
call is $.04 and
The Resulting
Default Price
The Resulting
Default Price
the elasticity of the
access charge is
-.398
$.32
$1.59
-.600
$.10
$.50
If the marginal cost of a coin
call is $.053 and
The Resulting
Default Price
The Resulting
Default Price
the elasticity of the
access charge is
-.398
$.20
$1.02
-.600
$.07
$.37
c. Bellwether Compensation.
112. Sprint argues that we should identify the most efficient carrier and base the dial-
around compensation amount on that carrier's costs, i.e., the so-called "bellwether" approach.
Sprint contends that we have "no duty to ensure that each provider will earn a fair return on its
investment, and that even using industry average costs would reward less efficient or less
competent operators and would thus deprive the public the benefit of competition." Dr.
Baumol agrees, stating that the default price should be set to allow the "maximally efficient"
payphone provider to recover its costs.
113. We decline to adopt a bellwether approach because there is insufficient
information on the record to conclude that the cost differences among PSPs with data on the
record are due to differences in efficiency. All of the parties that submitted data on the record
operate payphones in multiple areas and in multiple states. Each region of the country
experiences different costs. For example, payphones in dry climates require less protection from
rain than payphones in wetter climates. Therefore, a PSP in a more arid region could install a
less protective and thus cheaper enclosure than a PSP in a wetter region. Clearly, a PSP in the
wetter region should not be deemed less efficient because it needs to invest in a more expensive
enclosure. Similarly, we find that regional differences in labor costs and telephone line expenses
would affect the cost of a payphone operation. Sprint did not provide any justification
showing that any party was more efficient than another.
d. Caller-Pays Methodology.
114. Under a caller-pays compensation methodology, the calling party would pay for
dial-around calls by depositing coins or using a credit card. The caller-pays compensation
mechanism is a variation of the set use fee compensation mechanism. Under the set use fee
compensation mechanism, the IXC imposes a charge on the caller, collects payment from the
caller, and remits that money to the PSP. In the First Report and Order, the Commission
rejected the caller-pays approach and the set use fee approach on similar grounds. Despite
some parties' requests, we decline to adopt a caller-pays compensation methodology at this
time.
115. We expect IXCs to develop the technology necessary to employ targeted call
blocking, which will allow them to block calls from PSPs that they find to be excessively priced.
With the bargaining power afforded to them by the ability to block calls, we are hopeful that
IXCs will negotiate privately with PSPs for fair and mutually agreeable compensation
amounts. Our preference is for IXCs and PSPs ultimately to enter into privately negotiated
agreements establishing compensation amounts for dial-around calls. Although some economists
would argue that a caller-pays methodology forms the basis for the purest market-based
approach, we find that the statutory language and legislative history indicate Congress's
disapproval of a caller-pays methodology. We therefore conclude that we should monitor the
advancement of call blocking technology and any accompanying marketplace developments
before reconsidering a caller-pays compensation approach.
116. We also note that some parties urge us to adopt a "modified caller-pays plan."
Under a modified caller-pays plan, entities subscribing to a toll-free number would have three
options for handling calls made from payphones. First, the subscriber could elect to accept calls
from payphones and pay the charges associated with those calls that are passed through to it by
the IXC. Second, the subscriber could block all calls from payphones, eliminating the need for
compensation to the PSP. Third, the subscriber could elect to use a special "area code" (i.e.,
8XX, instead of "800" or "877" codes) that would enable it to block incoming payphone calls
that callers chose not to pay for with coins or a credit card. For the reasons provided above for
not instituting a mandatory caller-pays system, we also decline in this proceeding to impose the
modified caller-pays or 8XX plan. We note that a modified caller-pays plan is the subject of a
petition for rulemaking filed by AirTouch and that the Commission may examine the issue
further if that petition is granted.
e. Requests for Exemptions from Compensation.
117. Several petitioners assert that certain types of calls, such as "help line" or paging
calls, should be exempt from per-call compensation charges. Other petitioners urge us to
exempt from compensation requirements payphone calls to 800 hotlines and Electronic Benefit
Transfer ("EBT") services. Specifically, these parties request that we either waive the per-call
compensation amount or establish an 8XX number for non-profit organizations. The
petitioners supporting an EBT exemption claim that state contracts currently compensate EBT
service providers on a fixed price basis. Because the contracts were signed before the
implementation of per-call compensation charges, EBT service providers did not factor payphone
access costs into the contract terms. As an alternative method of compensating PSPs for EBT
and 800 hotline calls, these petitioners advocate increasing the cost of coin calls. Several of
these commenters encourage us to maintain jurisdiction over the regulation of payphones rates.
118. We find that Congress clearly instructed us in Section 276 to ensure compensation
for "each and every" call from a payphone. Congress explicitly exempted only two types of
calls: emergency calls (911) and TRS calls. Because Congress did not provide for any other
exceptions, we cannot grant an exception for these types of calls. Even if Congress permitted us
to grant an exception for EBT calls, we are unconvinced that we should do so. We understand
that when a caller is placing an EBT call, the buyer of that call will be the government. This is
insufficient justification, however, to deny payphone owners compensation for the use of their
payphone. We are confident that our default compensation amount is fair to all parties involved.
In receiving compensation, payphone owners will benefit from their decision to place their
payphone where consumers benefit from using it. In addition, carriers will pay no more than a
proportionate share of the payphone's joint and common costs.
119. We agree with APCC that EBT callers benefit greatly from the placement of
payphones in areas with EBT traffic. The people who use payphones to complete EBT calls
likely have no phone service in their home and are therefore likely to derive significant benefits
from conveniently located payphones. Payphone owners that receive fair compensation for EBT
calls are more likely to locate their payphones in areas where EBT calls are made, thus providing
service for people who rely on payphones as a phone of last resort. Payphones will thus be
placed where the amount of traffic warrants the payphone's existence, which is one of the
benefits of a deregulatory approach.
120. We also decline requests to artificially raise the local coin calling rate or to re-
regulate payphone prices so that calls like EBT calls can be made for free or at a reduced price.
We understand that because of our default compensation amount, government agencies will
ultimately spend more money to disburse benefits. Under Citicorp's proposal to raise the local
coin calling price, however, consumers will still pay for those calls, albeit in a different form.
Under Citicorp's proposal for free or reduced-price EBT calls, PSPs would not receive the extra
compensation from EBT traffic and therefore would have no economic incentive to locate
payphones according to the needs of EBT callers. Any such scheme also would involve creating
a subsidy, an option that Congress specifically eliminated in the 1996 Act.
121. We note that APCC states that some PSPs would be willing to reduce the amount
of per-call compensation if they find evidence that IXCs do the same. We encourage those
parties with budgetary concerns to meet with the IXCs and PSPs to reach a voluntary agreement
regarding per-call compensation.
3. Cost Calculation.
122. I