The ability to satisfy the entire market is also not fixed over time. For example, increased demand for a good or service can enlarge the market beyond the monopolist's economies of scale. Consequently, the enlarged market can be served by more than one

firm.

Rapid technological change has broken down the natural monopoly characteristics of the telecommunications industry and paved the way for a more competitive industry structure. One contributor to this change has been the development of alternative transmission technologies--point-to-point microwave, satellites, and coaxial cable--to the traditional technology of paired wires. The size of the market for telecommunications has also grown--reflecting the convergence of data processing and telecommunications--further dismantling the natural monopoly characteristics of the industry. For example, traditionally telecommunications terminal equipment consisted of essentially one product--the black dial telephone. As the use of computers has increased, however, the need arose to establish communications systems which would facilitate activities between computers. systems require a variety of terminal equipment, much of which has been made available through advances in computer and electronics technology. This has also changed the kinds of services provided, moving beyond simple voice communications. voice communications. For example, digital networks have been established to meet computers' specialized data transmission needs. Services have developed to allow disparate computers to communicate.

Such

Reacting to this technological change, FCC, supported by the courts, over the last 20 years has issued a series of decisions which have allowed competition into the manufacture of telecommunications terminal equipment and into the interstate provision of telecommunications services.

The primary rationale FCC offered in its decisions to allow competition in the terminal equipment sector was the consumer's right to interconnect with the telecommunications system equipment of his or her own choosing so long as the equipment was not harmful to the network. Natural monopoly issues in terminal equipment were not raised since FCC recognized that this sector's economies of scale are not significant.

FCC offered several rationales in its series of decisions introducing competition in interstate services. First, it reasoned that the public would benefit from the dynamic nature of increased competition. These benefits would include increased technical innovation, the introduction of new techniques and services, potentially lower costs, and increased responsiveness on the part of existing carriers.

In addition, the Commission reasoned that the new common carriers that were providing these services were not entering a fixed homogeneous market. As a result, these carriers could be

expected to satisfy demands which were not being met by existing carriers and, therefore, expand the size of the aggregate market. Finally, FCC felt that competition in interstate services was in the public interest and would further the policy goals of the Communications Act. Appendix IV contains a chronology of key FCC decisions allowing competition.

This series of decisions and the resulting court cases have altered the structure of the telecommunications industry. While the established firms still exist and continue to dominate the industry, they are competing with new, small carriers in many markets. In other markets, however, the established dominant firms still operate as de facto monopolists. This has created a need for FCC to expand its regulatory approach beyond its traditional concern of potential abuse by carriers of their monopoly power to include ensuring fair competition between the established carriers offering monopoly and competitive services and new carriers offering only competitive services. In particular, a monopolist, even a regulated one, will have a strong incentive to practice "monopolistic cross-subsidy" whereby its protected monopoly services are charged rates much higher than costs, yielding high rates of return while existing or potentially competitive services are charged rates much lower than costs, yielding low or negative rates of return. FCC has tried to ensure in its regulation that the monopoly services, therefore, do not cross subsidize the competitive offerings or that monopoly services' consumers do not bear a portion of the cost of the competitive offerings.

ORGANIZATION OF FCC

COMMON CARRIER ACTIVITIES

FCC is an independent Federal agency headed by seven Commissioners, one of whom serves as Chairman. Commissioners are appointed by the President and approved by the Senate for terms not to exceed 7 years. The Commissioners supervise all FCC activities, delegating responsibilities to staff units, bureaus, and committees of Commissioners.

In fiscal year 1981 FCC budgeted about $14 million and 322 positions for its common carrier activities. Most FCC work in this area is carried out by its Common Carrier Bureau whose functions include

--developing, recommending, and administering common carrier policies;

--conducting adjudicatory and rulemaking proceedings, in-
cluding rate and service investigations;

--determining the lawfulness of carrier tariffs;

--acting on applications for service, facility and radio
authorizations;

--reviewing carrier performance;

--Conducting economic research and analysis;

--administering Commission accounting and reporting
requirements;

--conducting compliance and enforcement activities; and

--recommending for FCC prescription annual depreciation
rates for classes of communications plant.

OBJECTIVES, SCOPE, AND METHODOLOGY

The purpose of this review was to evaluate FCC's program for regulating domestic telecommunications common carriers. Our review drew on an earlier report 1/ which set out the three major issues facing the Congress in the domestic common carrier area.

--What domestic common carrier telecommunications policy
goals should the United States pursue?

--What industry structure should provide common carrier

services?

--Can the present methods for regulating the common carrier industry be improved?

In particular, we examined FCC's activities in regulating the common carrier industry with special attention given to FCC's regulation of the American Telephone and Telegraph Company (AT&T). We did this for two reasons. First, from our analysis, as will be discussed in greater detail in chapter 2, AT&T is a dominant carrier in the industry. As a result, it possesses market power which might be abused and it could take advantage of an incentive to thwart competition by engaging in anticompetitive practices such as cross-subsidy. Second, reflecting this potential, FCC over the last 20 years has focused the majority of its regulatory activities for preventing monopoly abuses and anticompetitive practices on AT&T. Consequently, FCC's actions vis-a-vis AT&T served as the primary, if not the sole, example of its execution of its regulatory responsibilities and thus a major focus of our review. 2/

1/"Developing a Domestic Common Carrier Telecommunications Policy: What Are The Issues?" (CED-79-18, Jan. 24, 1979).

2/While FCC also regulates international common carriers, our review did not focus on this aspect of their program because we had covered this subject in two earlier reviews. See "Responsibilities, Actions, and Coordination of Federal Agencies in International Telecommunications Services" (CED-77-132, Sept. 29, 1977), and "Greater Coordination and a More Effective Policy Needed for International Telecommunications Facilities" (CED-7887, Mar. 31, 1978).

Our

In reviewing the Commission's regulatory program, we had two objectives. Our first objective was to assess the methods FCC uses in implementing for monopoly common carriers a system of price/earnings regulation which involves rate of return/rate base regulation. We examined FCC's activities regarding (1) setting an allowed rate of return, (2) assessing the reasonableness of operating expenses, (3) approving additions to the rate base, (4) approving accounting and depreciation practices, and (5) judging the reasonableness of individual tariffs (chs. 3, 4, and 7). second objective was to review the regulatory problems associated with introducing competition into domestic telecommunications. We examined the actions FCC has taken to prevent anticompetitive behavior against new entrants by dominant common carriers. These actions include (1) creating cost standards to judge the reasonableness of rates and to prevent cross-subsidy (ch. 4), (2) revising the Uniform System of Accounts (ch. 5), (3) using separate subsidiaries as an additional safeguard against cross-subsidy or other anticompetitive actions (ch. 6), and (4) developing access charges to ensure nondiscriminatory interconnection (ch. 8).

To accomplish our objectives, we initially reviewed the economic literature to identify the components of a traditional regulatory program and any relevant alternatives. We also sought in the literature review, information on potential areas of anticompetitive behavior by dominant common carriers and the efficacy of methods to mitigate such behavior. This was done to provide a benchmark against which we could compare FCC's program.

To provide an additional benchmark, we visited three representative State regulatory commissions (New York, Michigan, and Wisconsin) suggested to us by FCC and the National Association of Regulatory Utility Commissioners. We obtained a perspective of how their regulatory programs worked. We also contacted two other Federal regulatory agencies to discuss the aspects of their programs which were relevant to FCC's activities.

We next reviewed FCC decisions over the last 20 years in regulating domestic common carriers and preventing anticompetitive behavior. As part of this work, we interviewed present and former FCC officials and reviewed FCC documents and written comments filed on FCC actions by members of the public and representatives of the industry. We also reviewed legislative proposals and associated hearing records as well as court decisions.

As part of our assessment, we contacted officials in the domestic common carrier industry, representatives of industry associations, and other Federal agencies, most notably the National Telecommunications and Information Administration and the Department of Justice. All of the groups we contacted are listed in appendix II. In addition, we hired three consultants knowledgeable in the field of common carrier regulation. These consultants provided advice and expert opinion on the report. (See app. III.)

Our review was conducted at FCC headquarters, Washington, D.C., and its Common Carrier Bureau field office in New York City from June 1979 through July 1981. During this time, we worked with two other legislative agencies. We provided background information to the Congressional Budget Office to assist it in assessing the budgetary impact of H.R. 6121, "The Telecommunications Act of 1980," which was being considered by the 96th Congress. We also have maintained an ongoing working relationship with the office of Technology Assessment as part of its study of Telecommunication Technology and Public Policy. This contact included reviewing draft material it developed relative to its study.

In August 1980, while we were conducting our review, Peter W. Rodino, Jr., Chairman, House Committee on the Judiciary, requested our comments on certain portions of H.R. 6121 dealing with separate subsidiaries. Based on the work we had done as of that date, we provided our comments in a letter dated September 5, 1980, (B-200146, CED 0-371).

Our analysis and evaluation of FCC's Computer II decision (77 FCC 2d 384 (1980)) in chapter 6 deals only with the adequacy of the structural separation and procompetitive safeguards which the agency has required as a condition for the participation of the dominant carrier in "deregulated" offerings of enhanced services and terminal equipment. We did not consider the more fundamental, threshold question of AT&T's ability to engage in these activities at all under the terms of a 1956 Consent Decree entered into by it and by the Department of Justice in settling an antitrust action brought by the Government in 1949. The construction or interpretation of the Consent Decree and what the decree permits AT&T to do is a matter of dispute between FCC and Justice.

On March 4, 1981, AT&T petitioned the U.S. district court with jurisdiction over the 1956 Consent Decree to clarify the decree to allow it to participate in deregulated, competitive service and equipment offerings in the manner provided for in FCC's Computer II decision. 1/ As of July 1, 1981, the court had not ruled on the petition.

Further, 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. 2/

1/United States v. Western Electric Company, Inc. 17-49, (Dist. Ct. for the Dist. of New Jersey).

Civ. No.

2/United States v. American Telephone and Telegraph Company, No. 74-1698 (Dist. Ct. for the Dist. of Col.).