Applications of Cost Proxy Models Universal Service William W. Sharkey* and D. Mark Kennet** November 2000 * FCC and The World Bank ** George Washington University and The World Bank

November Universal Service Objectives and Funding Mechanisms §Provide “affordable” service to customers in “high cost” areas §Make implicit subsidies explicit §Base subsidies on forward looking, not embedded, cost §Subsidies should be transferable between carriers

November Implementation of a Universal Service Program in the U.S. §Some rural carriers question the reliability of proxy models §Some large incumbent carriers question the FCC’s input values and the funding mechanism (based on statewide average costs) §Both federal and state regulators are concerned about the size of the high cost fund

November Results of the FCC Synthesis Model for Universal Service §High cost support is driven primarily by the cost of the local loop

November FCC Synthesis Model (cont.) §Loop costs are driven by the density of the subscriber base

November Conclusions on Use of Proxy Models for Funding USO §Models provide a very reliable method to estimate the relative costs of regions within a country §Whenever a model based approach replaces an earlier approach there will be winners and losers §The open architecture of a model allows all parties to comment on and recommend changes to model structure or input values

November Use of Proxy Models for Pricing of Unbundled Network Elements §TELRIC is designed for this objective §Quality of service assumed in model architecture should adequately represent the incumbent carrier’s network §UNE rates must be compensatory l Independent calibration of model desirable l UNE prices should reflect prices for long term contracts in order to reduce the incentives for opportunistic behavior by entrants

November Use of Proxy Models for Pricing of Transport and Termination §A proxy model can give guidance for setting both rate structure and rate level §Use of a model forces the regulator to accurately estimate relevant economic inputs (e.g. peak vs. off-peak usage)

November Some Results of FCC Synthesis Model

November Other Applications of Cost Proxy Models §Targeted universal service support (estimating the incremental cost of high cost customers) §Estimation of productivity factors §Competition policy (e.g. predicting the viability of local competition) §Industrial policy (e.g. estimating the cost of broadband infrastructure investment)

November Preliminary Results on Targeted Universal Service in Portugal §We ask the question: In a mixed urban-rural region typical of much of Portugal, what percentage of lines are subsidized by current prices? §The model addresses this by calculating a cost radius about each central office such that lines within the radius cost less than a benchmark l One benchmark is overall average cost for the region – this gives conservative estimate of subsidy l Another benchmark is average revenue

November Conclusions §Proxy models provide a transparent, verifiable and robust tool for estimating a telecommunications cost function §Proxy models can be used for several regulatory purposes, including funding of universal service and interconnection pricing §Input prices should be determined in an open proceeding §Where possible, proxy model outputs should be calibrated using other benchmarks