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was made subject to an examination in the Computer II proceeding of the issues raised by a carrier's provision of peripheral devices which incorporate computer information processing functions.

These changes in communications and data processing technology, led FCC to conclude that "technology may have rendered meaningless any real distinction between 'terminals' and computers." FCC further concluded that a revised definitional structure, standing alone, would not adequately resolve the issues, and that the regulatory problems arising from the interplay of data processing and communications would have to be addressed by way of a more comprehensive approach. The approach would need to accommodate the market applications of computer processing technology and consider the realities of the marketplace and user needs.

Throughout the protracted Computer II proceeding, which was initiated in 1976 and ended in late 1980, with the Commission's Final Decision on Reconsideration, 1/ the Commission continued to wrestle with the difficult problem of devising a workable definitional approach. FCC sought an approach which would distinguish regulated communications services from unregulated data processing services, as well as dealing with other important issues, for example (1) the need to define the appropriate scope, nature, and mode of regulation to be applied to innovative service and product offerings of common carriers and (2) the desire to somehow find a way to allow AT&T to participate in the evolving communications/ data processing markets given the 1956 Consent Decree.

The Commission's final decision in Computer II was adopted on April 7, 1980. This decision drew a boundary between "basic services" (i.e., traditional "pipeline" transmission services) and "enhanced services" (see p. 17) made possible by rapidly evolving computer and electronic technology. The decision also provided for FCC forbearance from traditional title II common carrier regulation in the case of enhanced service and terminal equipment offerings 2/ of common carriers under its jurisdiction. As an alternative to traditional price/earnings regulation in this area, FCC proposed imposing a regulatory scheme involving a separate subsidiary requirement (an extension of the maximum separation concept developed in Computer I) for carriers deemed

1/In a real sense, the Computer II proceeding (77 FCC 2d 384 (1980)) is far from over. The complicated details of its implementation have yet to be worked out.

2/Customer premises equipment (CPE) is a term which is used interchangeably with the expression "terminal equipment" to signify those devices, ranging in sophistication from conventional black dial telephones to state-of-the-art computer terminals, which are located at the customer's premises and attached to the communications network.

dominant (in the final decision this was determined to be AT&T and GTE) as well as an unlimited resale requirement designed to ensure the continued widespread availability of quality "basic" telecommunications services for the benefit of the public and for use as the foundation for providing a variety of enhanced services.

Much of the final decision was devoted to a discussion of the specific conditions, separation requirements, and competitive safeguards which would be imposed on dominant carriers as prerequisites for their participation in competitive offerings of enhanced services and deregulated terminal equipment. The final decision also set forth FCC's rationale for concluding that its alternative regulatory scheme would permit AT&T's participation in enhanced service and terminal equipment offerings, notwithstanding the constraints imposed by the 1956 Consent Decree.

On Reconsideration of its Final Decision in October 1980 (84 FCC 2d 50 (1980)), the Commission made relatively few changes to the regulatory framework and requirements set forth in the final decision other than to remove GTE from the category of dominant firm and, as a result, from the requirement of establishing a fully separated subsidiary with all of the attendant Computer II conditions and requirements. Henceforth, only AT&T would be subject to the full range of Computer II regulatory requirements and competitive safeguards.

In both its final decision and in its reconsideration of Computer II, FCC had relatively little to say on the specific form, organization, and capitalization of separate subsidiaries or on the grouping of product and service offerings within separate subsidiaries. Regarding the question of financing separate subsidiary operations, including the valuation and transfer of assets to the separate subsidiary(ies), the Commission stated that it would be appropriate to wait until the carrier submits its plan for capitalization of the separate entity before considering questions of outside financing and related considerations. The Commission's decision allows, but does not require, the creation of multiple separate subsidiaries for the offering of various types of enhanced services and customer premises equipment. Thus, a carrier may choose to provide both enhanced services and customer premises equipment through a single separate subsidiary which may also engage directly in the manufacture of terminal equipment. There is every reason to believe that a carrier would prefer this type of conglomerate organization which provides maximum internal flexibility and reduced visibility for regulatory scrutiny over a multiple separate subsidiary organizational scheme which would have just the opposite effect.

Under the Commission's present time table for implementing Computer II, the Commission will require all new carrier terminal equipment offerings to be provided on an unbundled and detariffed basis as of March 1, 1982. By that date also, all enhanced services offered by AT&T through facilities used in

interstate communications will have to be provided through the "separate subsidiary structure" provided for in Computer II.

ALTERNATIVE APPROACHES TO

THE PROMOTION OF COMPETITION

Although FCC in its Computer II Decision has focused on the separate subsidiary device as a means of nurturing and protecting emerging competition in telecommunications product and service offerings, two other approaches--market segmentation and divestiture--have been suggested.

The difficulties inherent in pursuing a policy aimed at encouraging the growth and spread of telecommunications competition wherever feasible and at the same time curbing the incentives for anticompetitive abuse of market power constitute a significant challenge for policymakers and regulators alike. The difficulty in fostering and preserving effective competition in a monopolydominated industry is so great, in fact, that some feel there is no alternative but to segment the industry into monopoly and competitive sectors and to preclude the anticompetitive abuse of monopoly power by excluding the dominant firm entirely from competitive offerings. Others suggest that the optimal solution lies in divestiture, that is, the restucturing of the dominant firm through a forced spinoff of certain operations in such a way as to reduce or eliminate the firm's monopoly power, and thereby alter its incentives and its ability to behave anticompetitively.

Limiting the dominant carrier to the provision of basic telecommunications services

Those who advocate limiting the dominant carrier to the provision of regulated, basic telecommunications services argue that its overwhelmingly dominant position in the industry makes it virtually impossible for regulatory authorities to effectively oversee and regulate its participation in competitive markets in such a manner as to ensure against cross-subsidy, predatory pricing, and other forms of anticompetitive abuse of market power. To obviate such problems and to ensure fair and effective competition in those markets where competition is deemed to be, at least potentially, workable, it is suggested that the dominant carrier be confined essentially to the role of a carrier's carrier, that is, providing the basic transmission capacity which would be available for purchase on an equal and nondiscriminatory basis to all comers to satisfy their particular telecommunications needs and to serve as the transmission building blocks for a wide array of enhanced telecommunications services offered by other carriers.

Although confining the dominant carrier to the role of carrier's carrier could simplify the task of the regulatory authorities, at least in so far as the problems of cross-subsidy and other forms of anticompetitive conduct are concerned, there are

reasons for questioning whether it would allow society to realize the full benefits of competition. In economic terms, such a constraint on the role and potential contribution of the dominant carrier may not be as efficient or desirable a policy alternative as one which would permit the firm to participate as a vigorous competitor, and make its full contribution toward achieving the efficiency and innovative potentials inherent in rapidly evolving telecommunications technologies. This presumes, of course, that a way can be found to ensure full and fair competition, to prevent the dominant firm from overrunning competitive markets solely on the basis of its monopoly power and not its efficiency.

Divestiture

Many observers of the telecommunications industry seem to prefer a more positive and pro-competitive approach to the problem of monopoly power than one which consists, essentially, of excluding the dominant carrier from providing anything but basic transmission services. Their alternative is often divestiture, that is a restructuring of the carrier involving the spin-off of selected aspects of its operations into fully independent and competitive entities.

The United States Department of Justice is presently engaged in an antitrust action against AT&T which alleges attempts by the firm to monopolize the domestic telecommunications industry and which seeks the divestiture of various operations and associated assets of the firm. Because this matter is still in litigation, we have not addressed ourselves to this area and will refrain from comment on the issues involved.

SEPARATE SUBSIDIARIES AS

REGULATORY AND POLICY TOOLS

The use of the separate subsidiary device--essentially a corporate organizational form--as a means for accomplishing regulatory purposes and achieving public policy goals is a relatively novel and untested concept. None of the parties we contacted-including FCC and Justice officials, as well as industry experts and officials of major telecommunication firms--were able to shed much light on the origins of the concept nor on the economic rationale for its application as a regulatory and public policy tool. A number of parties were skeptical about the efficacy of separate subsidiaries as a means of preventing abuse of monopoly power and had misgivings about relying on separate subsidiaries as the chosen instrument for promoting a public policy favoring competition in the provision of telecommunication products and services.

To appreciate the strengths and weaknesses of the separate subsidiary device as a pro-competitive regulatory tool, it is important to understand what separate subsidiaries can and cannot accomplish. First and foremost, the separate subsidiary requirement does not fundamentally alter the economic incentives of the firm on which it is applied. Second, a separate subsidiary

requirement, applied as a regulatory tool, is essentially nothing more than a complement to--really an extension of--accounting techniques which are aimed at identifying, allocating, and partitioning costs and revenues involved in providing various telecommunications products and services. Separate subsidiaries may enhance the visibility and auditability of intracorporate transactions, but they in no way eliminate the manifold difficulties and anticompetitive potential inherent in the allocation of joint and common costs. Finally, separate subsidiaries are not a panacea, a cure-all, or a self-sufficient solution to the problem of monopoly power and its abuse. Separate subsidiaries, because they solve little or nothing in themselves, imply a continuing and intensive regulatory effort, including a heavy reliance on the very cost allocation, accounting, and auditing techniques which have proven so troublesome, difficult, and inadequate in the past in their application to traditional rate of return/rate base regulation and as a means of preventing cross-subsidization of competitive offerings.

Separate subsidiaries do not alter corporate incentives

Imposing a separate subsidiary requirement on a dominant firm does little or nothing to alter the incentives of the overall firm or make the incentives of the separate subsidiary significantly different from those of the corporate parent. This is so because a separate subsidiary requirement in itself does not alter the links of ownership and control which result in the separate subsidiary's subordination to and identification with overall corporate goals and strategy. The governing incentive of the separate subsidiary will be to maximize the profitability of the overall firm and to serve as an instrument of corporate policy in pursuit of this objective.

A separate subsidiary merely serves the function of drawing a line of demarcation, a boundary between the parent and its affiliate. With its provision for separate books of account and records, it provides a means of tracing transactions between the two--something to look at, investigate, and audit.

FCC has clearly recognized the limitations of the separate subsidiary in this respect. In the final decision in its Computer II proceeding, for example, the Commission acknowledges that:

"A separate subsidiary requirement, from a purely
structural perspective, does not guarantee a com-
petitive marketplace because it does not signifi-
cantly change the incentives of a firm upon which
it is imposed. The requirement does not impart an
incentive to operate the subsidiary in a manner
that would detract from the overall profitability
of the parent corporation. Thus, in general, if

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