-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO/RCED-00-38		

TITLE:     TELECOMMUNICATIONS: Development of Competition in Local
Telephone Markets

DATE:   01/25/2000 
				                                                                         
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GAO/RCED-00-38


A Report to the Subcommittee on Antitrust, Business Rights and Competition,
Committee on the Judiciary, U. S. Senate

January 2000 TELECOMMUNICATIONS Development of Competition in Local
Telephone Markets

GAO/RCED-00-38

Resources, Community, and Economic Development Division

Lett er

B- 283167 January 25, 2000 The Honorable Mike DeWine Chairman The Honorable
Herb Kohl Ranking Minority Member Subcommittee on Antitrust, Business Rights

and Competition Committee on the Judiciary United States Senate

The breakup in 1984 of the American Telephone and Telegraph Company (now
called AT& T) promoted competition in the long- distance and telephone
equipment markets. The breakup was not, however, designed to promote
competition in local telephone service markets 1 since it was assumed that
these markets were likely to remain monopolistic. By the early 1990s, some
companies had begun to enter local telephone markets and compete against
incumbent carriers, particularly in large cities, prompting some states to
make regulatory changes to encourage further entry. Ultimately, many experts
came to believe that more competition in the provision of local telephone
service was possible but would not fully develop without significant
revisions to communications law. With the enactment of the
Telecommunications Act of 1996 on February 8, 1996, the Congress sought to
increase competition in local telephone and other telecommunications
markets. The law imposed a variety of obligations on incumbent local
telephone companies that were designed to open their networks to
competitors. Six months later, the Federal Communications Commission (FCC)
issued its first major set of rules implementing the provisions of the act
affecting local telephone markets.

1 Local telephone service includes calls that are made within a designated
geographic area or locality without payment of long- distance charges.

You asked us to provide information on (1) the development of competition in
local telephone markets and the market strategies employed by new carriers
in five states under the 1996 Telecommunications Act and (2) the key issues
affecting that development and the enforcement activities of federal and
state regulators to address those issues. 2 To respond to these questions,
we visited five states: California, Illinois, New York, South Carolina, and
Texas. (App. I discusses the criteria we used to choose these states.) In
these states, we interviewed competing carriers, incumbent carriers, and
state public utility commissions. We also surveyed all 50 state utility
commissions to obtain information on the development of competition in local
telephone markets and on the state commissions' activities (see app. II). In
addition, we reviewed relevant laws and FCC proceedings.

Results in Brief To date, little competition has emerged in local telephone
markets, but new competing carriers are pursuing several different market
strategies.

According to data from FCC and the industry, incumbent local telephone
service providers controlled all but about 3 percent of the traditional
wireline local telephone service market as of December 1998- the most recent
date for which data were available. The number of lines competing carriers
serve has, however, increased rapidly, approximately tripling in 1998 alone.
We found, as have FCC and others, that competing carriers have concentrated
on serving relatively profitable urban business communities. At the same
time, some of the competing carriers we interviewed in the five states we
visited were also serving other markets- residential customers and customers
outside the largest cities. The competing carriers we interviewed were
delivering services through all of the methods envisioned by the 1996 act:
reselling- or acting as retailers of- incumbents' services, leasing parts of
incumbents' networks, or constructing their own facilities. Finally, an
important competitive strategy being undertaken by both competing and
incumbent carriers is the

2 This report is the second in a series of three reports GAO is issuing for
your Subcommittee on the development of competition in telecommunications
markets. The first report examined competition in the video market. (See
GAO/ RCED- 99- 158, July 8, 1999.) The third report will examine the
development of competition in the market for Internet services and is
scheduled for release later in 2000. It will focus on several issues,
including the technical characteristics underlying the provision of Internet
access by various types of companies (telephone, cable, wireless) and the
legal and regulatory differences governing the provision of Internet access
by these companies. As part of that assignment, we plan to review municipal
policies on open access issues.

simultaneous marketing and sale of a package of varied telecommunications
services including, for example, local and longdistance telephone service,
Internet access, wireless telephone service, and video services.

The further development of competition in local telephone markets will
depend, in part, on the resolution of several key issues that may have thus
far affected that development. In particular, the act requires incumbent
carriers to provide competing carriers with access to elements of their
telephone networks, such as equipment and facilities, to enable those
competing carriers to order and provide service to their own customers.
However, our discussions with competing and incumbent carriers in the five
states we visited, as well as with FCC staff, suggest that providing this
access has been difficult because these incumbents' systems were not
originally designed to be accessible to users external to the incumbent
carrier. In addition, some competing carriers in the five states told us
that negotiating the necessary agreement that details the terms and
conditions governing the business relationship between an incumbent and
competing carriers- referred to as an interconnection agreement- can take a
significant amount of time and thereby delay their market entry. Similarly,
some of the competing carriers we spoke with in the five states said that
negotiating the placement of their equipment in an incumbent's facilities
can take a significant amount of time. Incumbent carriers noted, however,
that they had invested money and other resources to make elements of their
telephone network accessible to competing carriers, had signed
interconnection agreements, and had allowed competing carriers to place
their equipment inside their own facilities.

Competing carriers in the five states also told us that the act and
accompanying rules needed better enforcement. We found, through our
discussions with FCC officials and our survey of staff at the 50 state
commissions, that state and federal regulators recognize their role is
changing to become less focused on traditional rate- setting regulation and
more focused on mediating disputes among carriers and enforcing laws and
regulations. Consequently, federal and state regulators are in the process
of adjusting their enforcement tools in ways that may lead to a greater
focus on enforcement. For example, FCC recognizes the need to develop
greater staff expertise on enforcement issues and recently created a new
bureau to focus exclusively on enforcement. FCC has also instituted a formal
expedited process for resolving complaints against telecommunications
carriers called the “accelerated docket.” In addition,
regulators at the state and federal level are working with carriers to

establish systems that will measure incumbent carriers' performance in
providing service to competing carriers and automatically assess penalties
against incumbent carriers that are not in compliance with the act.

The 1996 act and its implementing regulations imposed significant changes on
local telephone service markets. In the years since the act's passage,
competing carriers have developed entry strategies, incumbent carriers have
responded to the obligations imposed on them by the act and have
simultaneously undertaken their own new strategies, and regulators and the
courts have played roles in implementing and interpreting the act. Despite
the minimal competition that has emerged thus far in the market, further
competition seems likely to develop in local telephone markets because
competing carriers continue to expand their market share, these carriers are
using all entry modes envisioned by the act, legal and regulatory issues are
increasingly becoming clarified, and the packaging of varied
telecommunications services may enable firms providing other communications
services to effectively compete for local telephone customers. Moreover, FCC
and state regulators are taking steps indicative of greater enforcement
efforts in the future. This report contains no recommendations.

Background For the first hundred years after the invention of the telephone,
federal and state laws and regulations helped shape the structure of the

telecommunications industry. Over that period, the primary focus of these
laws and regulations shifted from controlling the market dominance of AT& T
to promoting competition in telecommunications markets. During the 1970s and
1980s, much of the effort to promote competition was geared toward the long-
distance telephone market, but the Telecommunications Act of 1996 was
designed, in part, to open local telephone markets to greater competition.
Technological changes in the telecommunications industry have also led to
changes in the structure of the telephone industry and in the laws and
regulations governing it.

Laws and Regulations Have After receiving patents for telephone technology
in 1876 and 1877,

Helped Shape the Structure Alexander Graham Bell and the Bell Telephone
Company (later called the

of the Telephone Industry American Telephone and Telegraph Company and then
AT& T) controlled

the developing market for telephone service. Once the patents expired,
however, a myriad of independent local telephone service providers entered
the market, and by 1907, the independents provided just over 50 percent of
local telephone service in the United States. AT& T responded by

reducing its prices in markets directly threatened by competitors,
purchasing independent telephone providers, and refusing to allow other
carriers to interconnect with its network. This refusal disadvantaged AT&
T's rivals because they were unable to route calls from their customers to
customers on AT& T's much larger network. These actions made it difficult
for independent companies to compete, and many accepted AT& T's offer to
acquire them.

By the 1930s, communications had become so important to the country that the
Congress passed the Communications Act of 1934, which, among other things,
created FCC and gave it authority over interstate telecommunications, while
leaving the oversight of intrastate telephone service to state regulators.
For many years, AT& T was the primary provider of local telephone service,
long- distance telephone service, and telephone equipment in the United
States. AT& T carried roughly 80 percent of the nation's local telephone
traffic by the early 1980s, and the remaining 20 percent of local traffic
was carried by the independent local companies unaffiliated with AT& T.
Beginning in the 1950s, new companies began trying to compete against AT&
T's monopoly in the telephone equipment and long- distance markets. In 1974,
the Department of Justice (DOJ) alleged that AT& T was undertaking
anticompetitive actions aimed at stifling this new competition and filed an
antitrust suit against the company. This case was resolved when a federal
court approved a consent decree entered into by DOJ and AT& T in 1982. Under
this decree, known as the Modification of Final Judgment, AT& T was required
to divest its ownership of the 22 Bell Operating Companies, its local
telephone subsidiaries. However, the company was permitted to continue
manufacturing telephone equipment and offering long- distance service and to
enter some markets from which it was previously excluded- notably the
computer market.

The 22 Bell Operating Companies were reorganized into seven regional
entities, which have since been reduced to four companies through mergers.
While the consent decree permitted the Regional Bells to provide service
within 161 designated local areas that covered much of the country, it
limited the lines of business these companies could enter to ensure that
their monopoly status in the local telephone market did not affect the
development of competition in other telecommunications markets. For example,
the Regional Bells were not permitted to provide long- distance telephone
service or to manufacture telephone equipment without obtaining a waiver
from the federal court.

By the late 1980s, new companies had begun to compete directly against
incumbent local telephone carriers in some locations by building facilities
that paralleled the incumbent telephone companies' networks- particularly in
large cities. 3 To enhance their likelihood of success, however, these
companies wanted some regulatory changes that would facilitate the
interconnection of their networks with those of incumbent carriers. Some
states enacted legislation or adopted regulations, and FCC put forth rules
designed to facilitate competitors' entry. 4 Meanwhile, the Regional Bells
were becoming increasingly dissatisfied with their exclusion from the long-
distance telephone market and the extensive control by the federal court
over their activities. These and other changes in the market led many
experts, as well as some Members of Congress, to believe that the
Communications Act was becoming outdated and that a major revision of the
law was needed.

The 1996 Act and Its The passage of the Telecommunications Act of 1996
constituted the first

Implementing Regulations comprehensive amendments to the federal
Communications Act since its

Establish a Framework for enactment in 1934. One of the key goals of the act
was to encourage

Greater Competition in competition in local telephone service. To do this,
the act imposed a variety

of obligations on incumbent carriers designed to facilitate new companies'
Local Telephone Markets

entry via three modes envisioned in the act. The three modes of entry are as
follows:

Resale. This entry method allows new companies to resell, or act as
retailers of, an incumbent's telephone services. Resellers purchase local
telephone services from an incumbent at wholesale rates and resell the
services to end users at retail rates.

Access to Network Elements. This entry method enables new companies to lease
parts of an incumbent's network- facilities and equipment that are used to
provide local telephone service- at cost3

Incumbent local telephone companies include the Regional Bells as well as
many other independent local telephone carriers that were providing local
telephone service before the 1996 act was passed.

4 For example, in 1989, the New York Public Service Commission required New
York Telephone, part of NYNEX, to allow certain types of competitors to
interconnect with its network. Also, in 1995, the Illinois Commerce
Commission approved part of Ameritech's “Customer First Plan,”
under which Ameritech made some pieces of its network available to competing
carriers. In exchange, Ameritech expected to obtain pricing flexibility and
approval to offer long- distance telephone service in its service region.

based rates. These leased parts of the incumbent's network are generally
referred to as “unbundled network elements”- also known as UNEs-
because they are specific, or discrete, parts or functions of the telephone
network. Entrants provide local telephone service by leasing designated
pieces of the incumbent's network or by leasing some pieces and combining
them with their own facilities.

Construction of New Facilities. Finally, carriers may enter local telephone
markets by building entirely new facilities. Under a full “facilities-
based” method of entry, an entrant builds all the facilities that it
needs to serve customers, including the “last mile,” or the
connection to a user's premises. This method of entry still requires the
incumbent to allow entrants to interconnect with the incumbent's network.

To facilitate competitors' entry into local telephone markets using these
methods, the act prohibits states from restricting entry into the local
telephone market and requires all telecommunications companies to
interconnect their networks and facilities with those of others. While other
obligations of the act were imposed on all local telephone carriers- for
example, all telephone companies must allow users to keep their existing
telephone numbers when possible and provide access to operator services and
directory assistance without undue delays- additional competitionenhancing
obligations were imposed only on incumbent carriers. 5 Among other things,
incumbent carriers are required to negotiate, in good faith, agreements that
lay out terms governing the interconnection of their networks when requested
by competitors; allow entrants to resell the same services that the
incumbents provide to their own retail customers; make UNEs available for
purchase at rates that are based on their cost; 6 and allow competing
carriers to “collocate,” or place their own equipment in
incumbents' central offices. 7 In addition, the Congress required the
Regional Bells to demonstrate that they have adequately opened their
networks to competitors before they can provide long- distance 8 telephone
service in their designated local service areas. 9 Specifically, the act
lays out a 14- point checklist (47 U. S. C. 271), which generally requires
that a Bell Company demonstrate to regulators its compliance with the
interconnection and network access requirements detailed in earlier sections
of the act. 10

5 The market- opening obligations discussed here are contained in Section
251 of the Communications Act of 1934, as amended (47 U. S. C. 251). 6 The
act was not explicit about how “cost” should be calculated or
defined. However, FCC and state commissions are charged with making this
determination. 7 If the incumbent local exchange carrier can demonstrate to
the state commission that physical collocation is not practical for
technical reasons or because of space limitations, the carrier may provide
for “virtual” collocation. (47 U. S. C. 251( c)( 6)).

8 Long- distance service includes toll calls within “local access and
transport areas” (LATA) and across LATAs. The Regional Bells are
allowed to provide intraLATA toll service, but not interLATA toll service.
In the remainder of this report, when we refer to “long-
distance” telephone service, we are referring to interLATA toll
service.

9 The Bell Operating Companies were allowed to provide long- distance
telephone service outside their local service areas as of the date of the
1996 act's enactment. 10 Satisfying the 14- point checklist is a
determination that FCC must make in approving a Regional Bell's entry into
the long- distance market (see 47 U. S. C. 271( d)( 3)).

In August 1996, FCC issued an order implementing the local competition
provisions of the act. 11 Among the regulations included in that order, FCC
established rules about how interconnection and collocation were to be
provided, put forth a method that state commissions should use to establish
prices for interconnection and UNEs, 12 and specified which parts of an
incumbent's network must be made available to competing carriers (and are,
therefore, UNEs). One of the elements that must, under FCC's order, be
unbundled and provided to competing carriers as a UNE is an incumbent's
“operations support systems”- the computer systems and personnel
that entrants use to place orders and provision local telephone service. 13
After FCC released its rules, several telephone service providers and state
regulators challenged the rules before the U. S. Court of Appeals for the
Eighth Circuit. The Eighth Circuit overturned many of FCC's rules on the
grounds that the commission had exceeded its authority and misinterpreted
the law. Ultimately, in early 1999, the Supreme Court issued a decision that
addressed many of the issues raised in the Eighth Circuit decision. 14 The
Supreme Court, noting that the Telecommunications Act of 1996 was vague in
some respects, affirmed FCC's rulemaking authority to implement the local
competition provisions of the act and upheld most of FCC's rules. The case
was sent back to the lower court for further proceedings consistent with the
Supreme Court's decision.

Although FCC establishes nationwide guidelines for incumbent telephone
service providers and state regulators, state regulators themselves have
major roles in implementing key provisions of the act, several of which are
directly related to promoting local telephone competition. For example,
state commissions must approve or reject interconnection agreements, and
they have a role in arbitrating and mediating these agreements if asked to

11 This order was the first part of FCC's “competition trilogy,”
a set of rulemakings implementing the 1996 act. 11 FCC Rcd 15499 (released
Aug. 8, 1996). The trilogy also includes orders relating to other key facets
of telecommunications policy issues- universal service and access charges.

12 FCC determined that the prices charged by incumbents for UNEs should be
based on forward- looking economic costs and adopted a pricing methodology
known as “Total Element Long Run Incremental Cost.”

13 FCC also required incumbent carriers to provide resellers with access to
their operations support systems under section 251( c)( 4) of the
Communications Act. FCC further noted that providing nondiscriminatory
access to these systems could be viewed as a “term or condition”
of unbundling other network elements under section 251( c)( 3).

14 AT& T Corp. v. Iowa Utilities Board, 525 U. S. 366 (1999).

do so by the negotiating carriers. State regulators are also charged with
developing and implementing cost- based prices for interconnection and UNEs.

Technology of Telephone The technology used to transmit telephone calls has
evolved since the

Transmission Has Evolved invention of the telephone in 1877. In the
conventional telephone network,

Over Time “dialtone” is transmitted over a pair of copper wires
from a telephone

company's facility, known as a central office, to the caller's telephone
when the handset is lifted. As the caller dials another party's number, the
number pattern is received at the central office, and the call is routed
through the telephone network and transmitted to the called party's
telephone. When the call is answered, the two parties hear each other's
voices because telephones convert sound into electrical signals that are
transmitted through the telephone lines at both the calling and receiving
ends.

In recent years, the conventional telephone network has been modernized. For
example, a new generation of advanced electronic equipment is being
installed in incumbents' central offices to improve the transmission of
telephone calls. In addition, new delivery systems are being deployed and/
or adapted to provide local telephone service. For example, fiber- optic
cable- a higher- speed, higher- capacity alternative to copper wire- is
being deployed by both incumbent and competitive carriers. Cable companies
are also upgrading their facilities to transport two- way voice services
over their existing coaxial cable transmission facilities. Wireless
technologies, which do not require cables for the transmission of telephone
calls, are providing another alternative to traditional wireline local
telephone service.

While Little While competing carriers are still serving only a small portion
of the local

Competition in Local telephone market- approximately 3 percent- several
carriers have

entered the market using a variety of market strategies. These carriers are
Telephone Markets Has

serving primarily urban business customers; however, some competing Emerged,
New Carriers

carriers are also serving residential customers and those outside the
largest Are Pursuing Varied

cities. We found that competing carriers were using all of the modes of
entry envisioned by the Telecommunications Act of 1996- reselling

Market Strategies incumbents' services, leasing UNEs, and building
facilities. We also found

that the fundamental manner in which telecommunications services are
produced and marketed is changing as competing and incumbent carriers are
pursuing strategies to offer customers packages of telecommunications

services, such as local and long- distance telephone service, Internet
access, and video service.

Competing Carriers Provide According to FCC, as of December 1998- the latest
point for which data

Only a Small Percentage of are available 15 -there were more than 180
million local telephone lines in

Local Telephone Service the United States. Although no comprehensive data
are available on the

numbers of lines served by different types of carriers, information from
FCC's voluntary surveys and analysts' reports suggest that by the end of
1998, approximately 89 percent of these lines were served by six large
incumbent local telephone service providers (the four remaining Regional
Bell Companies, GTE, and the local telephone division of Sprint), about 3
percent were served by competing carriers, 16 and the remainder were served
by the many other independent incumbent carriers (see fig. 1).

15 At this time, FCC has only preliminary data for June 1999. 16 Because
competing carriers do not have to report the size of their customer base to
regulators and few participate in FCC's voluntary surveys, there is no
strictly reliable measure of the size of the market that bypasses
incumbents' networks. FCC reports that analysts' estimates of the market
also vary somewhat, generally placing competing carriers' market share
between 2 and 3 percent of the market. Using survey data on competing
carriers reported by New Paradigm Research Group, Inc., we estimate that
competing carriers are serving about 3 percent of the local market.

Figure 1: Market Shares of the Local Telephone Market, by Type of Carrier

3% Competing carriers

8% Other incumbent carriers

89% Six large incumbent carriers Market percentage held by six large
incumbent carriers Market percentage held by competing carriers Market
percentage held by other incumbent carriers

Note: Other incumbent carriers include over 1,300 mostly small local
telephone carriers. Source: GAO's analysis of FCC's and analysts' data.

Despite the small presence of competing carriers, our estimates- based on
data from FCC and the industry- show that the number of lines they serve
approximately tripled between December 1997 and December 1998 (see fig. 2).

Figure 2: Growth in the Number of Access Lines Served by Competing Carriers,
1997- 98

-

Percentage of Number of access lines total access lines served

served by competing by competing carriers

carriers (in millions) 3.50%

5.6 M 6

3.00% 5 2.50%

4 2.00%

3 1.50%

1.8 M 2

1.00% 0.50%

1 0.00%

0 1997 1998 Source: GAO's analysis of data from FCC and The 1999 CLEC Report
TM from New Paradigm

Resources Group, Inc.

While none of the competing carriers were serving large numbers of local
telephone lines, some of these carriers are large telecommunications
companies. For example, in 1998, one large telecommunications service
provider had total revenues of $53.2 billion from its provision of varied
telecommunications services- including long- distance and wireless services-
although only a small fraction of its total revenues are from local
telephone service. At the same time, many of the new companies providing
local telephone service are much smaller. For example, 16 of the competing
carriers we interviewed serve fewer than 100,000 local telephone lines, and
15 have less than $100 million in revenues. The six large incumbent
companies also vary considerably in size- the largest of these carriers as
of 1998 earned $26 billion from its provision of domestic telephone services
in that year and served about 41 million telephone lines, while the smallest
of these carriers earned $5 billion from its local telephone operations and
served about 7 million telephone lines.

Our analysis of the status of competition in local telephone markets was
limited because systematically collected data were not available on the
local telephone service that competing carriers provide throughout the
country. FCC recently acknowledged its own difficulties in evaluating the
degree of competition in its October 1999 Notice of Proposed Rulemaking on
Local Competition and Broadband Reporting. 17 In that notice, FCC stated
that more data on companies' provision of local telephone and broadband
services (such as high- speed connections to the Internet) are needed to
evaluate the effectiveness of the Commission's decisions and otherwise
understand the development of competition in these markets. Obtaining such
data would allow parties to better understand and evaluate the level of
competition in this evolving market.

Most Competing Carriers In its August 1999 report on competition in local
telephone markets, FCC

Focus on Urban Business provided statistical support showing that
competition is expanding most

Markets, but Some Choose rapidly in urban business districts. In addition,
staff at the state utility

to Serve Other Markets commissions we surveyed reported that competition was
developing more

rapidly in business markets than in residential markets. For example, staff
at 36 state commissions reported to us that large business markets were very
or somewhat competitive, while staff at 45 state commissions said that
residential markets were not very competitive or had no competition at all.
In addition, staff at many of the state commissions explicitly noted in
their comments that competition was developing most rapidly in urban
business areas within their states. Many of the incumbent carriers we spoke
to noted that the urban business market was one of the markets being
targeted by competing carriers.

Competing carriers are focusing on the urban business market because it is
generally more profitable than other local telephone markets. In particular,
the concentration of customers in urban areas reduces the cost of service
because it shortens the average length of the telephone line that connects a
customer's premises to a telephone company's primary facilities.
Additionally, business users can generate more revenue and be less costly to
serve because businesses are more likely than residential customers to buy a
greater volume and variety of telecommunications services. The greater
profitability of serving urban business markets is also related to the
prices- set by regulators- that incumbent carriers charge for telephone
service. Regulators set the rates that incumbent telephone companies

17 FCC 99- 283, Oct. 1999.

charge for local business telephone service, special features (such as
caller ID and voice mail), and long- distance telephone service at levels
that are high relative to cost so that they could set the rates for
residential and rural local telephone service at levels that are low
relative to the cost of providing the service, while still enabling the
companies to earn a profit. Thus, new carriers are likely to find it
profitable to serve urban business customers because incumbents' prices tend
to be high relative to the cost of serving these customers. This pricing
structure may change as FCC and the states work, as required under
provisions of the 1996 act, to make the subsidies that have been implicit
within the rate structure more explicit.

In the five states we visited, we interviewed 24 competing carriers that are
using a variety of market strategies and are often serving more than one
market segment. 18 Some of these carriers focused mostly on serving large
businesses in large cities, while others focused on serving businesses in
smaller cities, and more than half served at least some residential
customers. In addition, a number of these carriers were providing service
outside the urban business market, including the following:

Some competing carriers had chosen to serve smaller cities or smaller
businesses in order to focus their entry in areas where larger competing
carriers would be less likely to operate.

Several competing carriers were targeting small- and medium- sized
businesses by offering them the same kinds of personal service that larger
carriers offer only their largest business users. These companies told us
that by developing highly efficient support systems, they can profitably
offer relatively specialized services to these businesses.

Some competing carriers that were already providing video or longdistance
services to consumers in residential markets- in particular, cable and long-
distance companies- are focusing their entry in these areas.

18 One of the carriers we interviewed does not provide voice services.

In New York City, Chicago, and southern California, competing carriers were
choosing to serve residential customers in multiple dwelling units, which
include apartment buildings and condominiums. A carrier in southern
California told us that this market is attractive because a third to a half
of the residential customers in California live in multiple dwelling units.
In addition, because residential users are highly concentrated in these
buildings, they can be less expensive to serve. 19 Some carriers had found a
profitable niche serving residential

consumers who could no longer obtain telephone service from incumbent
providers because they had not paid their bills. These competing carriers
charge a prepaid amount as high as $49 a month for service strictly limited
to the local calling area.

Competing Carriers Are The 1996 act outlined three means by which competing
carriers could

Using All Modes of Entry provide local telephone service: reselling
incumbents' services, leasing

Envisioned by the Act incumbents' network elements, and constructing their
own facilities.

National data and our interviews with competing companies indicated that
entering companies are pursuing all of these means, to varying degrees.

Resale FCC reported that in December 1998, about 1.9 percent of the access
lines in the United States were being served by resellers. 20 In responding
to our survey of the 50 state utility commissions, staff at 25 of the
commissions said that resale constituted a major portion of competing
carriers' service to residential customers in their states, while staff at
18 commissions said that resale constituted a major portion of competing
carriers' services to business customers. In addition, in about 23 states,
commission staff reported that they expect the use of resale to increase in
both business and residential markets.

Although resale is the most common entry mode employed by competing
companies, the resellers we interviewed almost universally told us that
resale is not a profitable means of providing local telephone service. They
noted that resale can be a good way to enter the market quickly and build a
customer base before investing in facilities. However, these carriers told
us

19 Despite their focus on serving multiple dwelling units, competing
carriers undertaking this strategy told us they are having problems
accessing essential telephone facilities in these properties.

20 FCC's preliminary data for June 1999 suggest that resale has continued to
grow modestly as a percentage of access lines.

that they cannot earn a profit from reselling incumbents' local telephone
service because there is not a great enough difference between the wholesale
rates resellers pay incumbent carriers for service- rates set by state
commissions in accordance with specifications in the 1996 act- and the
retail prices resellers can charge their own customers. Nevertheless, one
competing carrier told us that carriers may pursue this strategy because of
the profits they earn by providing customers with packages of
telecommunications services.

Access to Network Elements FCC reported that in December 1998, only two-
tenths of 1 percent of the telephone lines in the United States were being
served by competing carriers that were leasing UNEs from incumbent carriers.
21 Nevertheless, FCC's data show that competing carriers have collocated
their equipment in the incumbents' central offices that provide almost 50
percent of the nation's local telephone lines, indicating that competing
carriers may have the potential to serve many more customers through the
leasing of UNEs. Staff at utility commissions in only four states said that
competing carriers were using UNEs to deliver a major portion of their
service to businesses, and staff in only two states reported that competing
carriers were using UNEs to deliver a major portion of their service in
residential markets; however, staff at 26 of the state commissions expected
the use of UNEs to increase in both residential and business markets in the
future. Additionally, 15 of the companies we interviewed were providing
local telephone service to some of their customers by combining incumbents'
UNEs with elements of their own networks.

21 FCC's preliminary data for June 1999 suggest that the use of UNEs has
grown markedly as a percentage of access lines, although the use of UNEs
still accounts for less than 1 percent of the market.

Competing carriers' decisions to provide service using UNEs depended, in
part, on the prices of these elements. Like the wholesale rates that
resellers pay incumbent carriers, the rates that entrants pay for UNEs are
set by state commissions in accordance with provisions of the act and
direction from FCC. FCC directed that the states use a forward- looking
economic cost methodology to set these rates. 22 Under this approach, rates
would be based on the forward- looking cost to incumbent carriers of
providing the UNE using the most efficient technologies currently available-
a method that may lead, in many cases, to rates that are lower than would be
realized under other cost methods. 23 In the five states we visited, the
commissions were in various stages of setting prices for UNEs.

Some competing carriers are attempting to provide local telephone service by
leasing an incumbent's entire set of UNEs- a method that has come to be
called the UNE- Platform. Although the act did not specifically mention the
UNE- Platform as an entry method, it did allow competing carriers to
purchase combinations of network elements. Some competing carriers told us
that because UNEs must be sold at rates based on cost, this entry method can
be more cost- effective than resale but still has the advantage of requiring
minimal investment. According to FCC, very little service is currently being
offered using the UNE- Platform. In responding to our survey, staff at only
one state commission reported that the UNE- Platform was the major method
being used by competing carriers to provide service to both business and
residential users in their state. In one of the five states we visited, the
Bell Company was being explicitly required to offer the platform, and a
competing carrier reported that, as a result, the company had acquired
upwards of 60,000 new local residential customers in that state during the
first 5 months of 1999. 24

Construction of Facilities The degree to which local telephone service is
provided by competing carriers that rely entirely on their own facilities is
not well known because these providers do not have to report information
about their businesses to

22 The appropriateness of the forward- looking cost method is currently
under review by the U. S. Court of Appeals for the Eighth Circuit. 23 FCC
has also directed states to “deaverage” UNE rates across urban
and rural regions so that UNE prices more accurately reflect the
differential cost to incumbents of providing UNEs in these different
settings.

24 In another of the states we visited, the incumbent carriers were being
required to offer the UNE- Platform as part of the standard interconnection
agreement.

regulatory authorities and do not purchase services on an individual
telephone line basis from incumbents. These full- facilities- based
competing carriers are employing a variety of strategies. For example, we
spoke to some carriers that were targeting business customers by deploying
fiberoptic cable within and around cities. Additionally, some carriers we
spoke to are reconfiguring existing cable systems or building new systems to
provide local telephone service mostly to residential customers. While
estimates show that full- facilities- based carriers were providing local
telephone service to only about 1 percent of the national market at the end
of 1998, FCC estimates that the amount of fiber- optic cable owned by
competing carriers increased fivefold between 1995 and 1998. Some
fullfacilities- based carriers are also using wireless technologies. For
example, the wireless carrier we interviewed was using a fixed wireless
technology to serve customers primarily in multiple dwelling units in large
cities.

Competing and Incumbent Both competing and incumbent carriers are providing
packages of

Carriers Are Providing telecommunications services- including local
telephone service, longdistance

Packages of service, data services, Internet access, video service, wireless

telephone service, and directory assistance- to consumers. 25 This focus is
Telecommunications

generally attributed to consumers' desire for a “one stop shop”
for their Services and Entering New

varied telecommunications needs. Additionally, some savings in the cost of
Markets

providing these services can occur when several services are offered over
the same infrastructure or when the marketing and administrative functions
for several services can be combined. The tendency of carriers to provide an
array of telecommunications services is fundamentally changing how carriers
operate in the market and how telecommunications services are bought and
sold.

To provide an array of services, many communications companies are
redesigning their infrastructures to expand their capabilities. For example,
cable television companies are modifying their networks- which were
initially designed for one- way video transmission over coaxial cable wire-
to accommodate high- quality, two- way voice and data transmissions as well.
Similarly, incumbent telephone companies are developing highercapacity
transmission technologies to remain competitive in the market for

25 Another new line of business for incumbent carriers- though not a part of
the package of services they supply to retail customers- is the wholesale
services (i. e., resale and UNEs) they provide to competing carriers.
Officials of several of the incumbent carriers said they recognize that
these wholesale operations are becoming increasingly important.

high- speed interactive data transmission (for example, Internet access). In
addition, some mobile and fixed wireless companies are providing telephone
service, data services, and, in some cases, video services.

Both competing and incumbent carriers are also entering new markets,
sometimes through corporate mergers. For example, some of the incumbent
carriers told us they were starting to enter other incumbents' traditional
territories to compete- that is, they are becoming competing carriers in
other incumbents' regions. In addition, both competing and incumbent
carriers are entering new markets by merging with other companies whose
telecommunications infrastructures or service offerings complement their
own. For example, some of the competing carriers have been acquired by long-
distance companies. Also, Bell Atlantic expanded its service area by
acquiring NYNEX, and SBC expanded its area by acquiring PacTel, Southern New
England Telephone Company, and Ameritech. US WEST is awaiting FCC's approval
of its proposed merger with Qwest, a provider of data and long- distance
telephone services.

A unique challenge for the Regional Bell Companies in attempting to offer a
competitive package of telecommunications services is the prohibition on
their providing long- distance service within their service region until
they have received approval from FCC through the process outlined in the
1996 act. In December 1999, Bell Atlantic received approval from FCC to
enter the long- distance market in its New York region. 26 On January 10,
2000, SBC Communications filed an application with the FCC to provide long-
distance service within the state of Texas. The two remaining Regional Bell
Companies are pursuing FCC's approval but have made varying degrees of
progress toward attaining it.

Several Issues Affect Several issues may have slowed the development of
competition in local

the Development of telephone markets. Competing carriers, incumbent
carriers, and regulators

cited difficulties in making incumbent carriers' operations support
Competition in Local

systems- needed to perform critical business functions- accessible to
Telephone Markets

competing carriers. Competing carriers and regulators also cited
difficulties in negotiating interconnection agreements and obtaining
adequate collocation space as problems that may have inhibited or delayed
market entry. Additionally, some competing carriers stated that greater

26 After FCC's approval of the Bell Atlantic 271 application, AT& T and
Covad Communications challenged this approval in federal court.

enforcement of the act would help to foster a more competitive environment
in local telephone markets.

While Critical to the In its order on local competition implementing the
1996 act, FCC required

Development of incumbent local telephone carriers to give competitors access
to the

Competition, Equivalent incumbents' computer systems and personnel that
competing carriers need

to perform critical business functions- systems known collectively as Access
to Incumbent

operations support systems (OSS). 27 FCC specified that competitors must
Carriers' Operations

have access to incumbents' OSS so that they can perform business Support
Systems Has Been

functions such as ordering, provisioning, and maintaining telephone
Difficult to Achieve

service for their customers. 28 According to FCC, competing carriers must be
able to use these systems to perform these business functions as easily as
incumbents perform these functions for themselves in terms of quality,
accuracy, and timeliness. If incumbent carriers access these business
functions electronically, then they are required to provide competitors with
equivalent electronic access to these functions; likewise, if incumbents
perform these functions manually- by telephone or fax- then the same access
is required for competitors. 29 In responding to our survey, staff at nearly
all of the state regulatory commissions said that competitors' access to
incumbents' OSS functions is very important to the development of local
telephone competition.

Obtaining equivalent access to OSS functions is important for competing
carriers to attract and retain customers. The competing carriers we
interviewed often cited deficiencies in access to OSS functions as a serious
impediment to the development of competition. Some competing carriers noted
that incumbents' systems were frequently unable to complete electronically
placed orders without manual intervention, especially for

27 In its local competition order, FCC identified OSS as an “unbundled
network element” and determined that incumbents must provide access to
OSS functions under their duty to provide UNEs and their duty to offer
resale services. Incumbents must provide access to computer systems that
contain information related to telephone service, such as available service
plans and installation options, customer profiles, and the availability of
telephone numbers.

28 FCC specified five critical business functions: (1) pre- ordering
(developing the customer profiles- e. g., name, address, and existing
telephone services- necessary to place accurate orders for potential
customers); (2) ordering; (3) provisioning (executing customers' requests
for local telephone service); (4) maintenance and repair; and (5) billing.

29 For OSS functions for which there is no retail analog, incumbents must
provide access sufficient to give efficient competitors a “meaningful
opportunity to compete.”

complex orders. In addition, competing carriers noted that ordering services
from more than one incumbent carrier can be cumbersome because incumbents
use different ordering systems. Competing carriers also told us that
incumbents were not confirming orders and assigning installation dates in a
timely manner. Additionally, competing carriers told us that incumbents
occasionally left customers without telephone service by failing to transfer
them to the competitor's system at the designated time. Some carriers also
claimed that they are not notified in advance if the facilities at a
customer's site require special preparation before installation and are then
charged excessive fees for the special preparation. Finally, competing
carriers noted that incumbents' wholesale operations staff often failed to
handle service requests in a timely and effective manner, a problem that
carriers attributed partially to a lack of training and experience on the
part of incumbents' wholesale personnel.

Incumbent carriers acknowledged that there have been problems with adapting
their OSS to the needs of entering companies. Incumbents said that providing
comparable access to their support system functions is difficult, however,
because these computer systems were designed at an earlier time for internal
use by the incumbent, not for external use or use by other companies.
Incumbents also noted that giving competitors access to these complex
systems requires significant technical modifications, resources, and time.
They said they are expending significant effort to improve the ability of
competitors to access these system functions. For example, one incumbent
carrier said that it now offers competing carriers the choice of five
electronic systems and provides an electronic handbook on the Internet to
facilitate competitors' access. That incumbent also showed us materials that
it is using to train competing carriers' personnel to better use the
available systems, while another incumbent said that it is training its own
personnel to provide better service to its wholesale customers. However,
incumbent carriers said that problems still occur when competing carriers'
personnel make errors or are unwilling to use the appropriate electronic
systems.

An FCC official agreed with incumbents that an important reason access to
OSS is difficult to provide is that such systems were designed for internal
use. FCC officials further noted that there were no national standards for
OSS and, as a result, these systems varied considerably across carriers. A
DOJ official and state officials also told us that problems in accessing OSS
functions pose the primary impediment to the development of local telephone
competition. Additionally, staff at 27 state commissions reported that the
Regional Bell Company in their state was working to address OSS

issues and had made at least “some” progress. In the states
where the Regional Bell Companies are seeking authority to provide long-
distance service, the state commissions have been helping to address OSS
issues by testing incumbents' OSS. In one region, several state commissions
are cooperating with each other and with the incumbent carrier to test its
OSS functions.

Some Competing Carriers The 1996 act requires incumbent carriers to
negotiate agreements that

Cited Difficulties stipulate how and under what conditions competing
carriers will connect

their facilities and equipment with those of incumbents. 30 The act and
Negotiating Interconnection

FCC's implementing rules provide competing carriers with several options
Agreements

for developing interconnection agreements: negotiating their own agreement,
adopting an agreement that another carrier has negotiated with the incumbent
in that state, or choosing provisions from other signed agreements within
the state to form a new agreement or to combine with other newly negotiated
provisions. 31 The act authorizes state utility commissions to mediate or
arbitrate interconnection disputes between the carriers if requested by the
carriers and requires the state commissions to approve or reject all
agreements.

Some competing carriers were concerned that difficulties they are having
negotiating interconnection agreements may delay their market entry. These
carriers told us that incumbent carriers did not always negotiate contracts
in a timely manner and that disputes involving the agreements were sometimes
slow to be resolved. For example, one carrier told us that it can take
almost a year to negotiate an agreement with an incumbent. In an arbitration
proceeding involving another carrier, the arbitrator stated that the
incumbent carrier had not been negotiating in good faith as required by the
act. Some competing carriers told us that they opt into existing contracts
even when the contracts are not relevant to their needs because doing so
eliminates costly and time- consuming negotiations.

30 The terms and conditions of interconnection agreements are to be just,
reasonable, and nondiscriminatory. 31 The last of these options, known as
“pick and choose,” has been the subject of court challenges;
however, in Jan. 1999, the Supreme Court affirmed FCC's interpretation of
the statutory language that requires an incumbent carrier to allow competing
carriers to choose options from prior contracts signed by that incumbent.

Incumbent carriers, on the other hand, said they are working to facilitate
negotiations on interconnection agreements and point to a large number of
signed interconnection agreements as evidence that there are no major
problems for competitors in this area. According to a telecommunications
trade association, incumbent and competitive carriers had signed over 5,400
interconnection agreements nationwide as of February 1999, 3 years after the
1996 act became law. One incumbent carrier we interviewed said it had
concluded over 400 agreements that had been approved by the state and was
currently negotiating another 750. 32

The five utility commissions in the states we visited had approved and
arbitrated interconnection agreements. For example, in 1998, the Illinois
utility commission approved 37 agreements. In Texas, the public utility
commission has responded to complaints from some competing carriers by
developing a preapproved interconnection agreement that competing carriers
may adopt. While one competing carrier expressed concern that the terms of
the proposed interconnection agreement would not meet its needs, the staff
of the Texas commission noted that the agreement provides consistency and
addresses certain issues that earlier interconnection agreements did not
discuss.

Some Competing Carriers Under the 1996 act, an incumbent carrier must allow
competing carriers to

Reported Difficulties collocate, or place their equipment in the incumbent's
central offices, on

Obtaining Adequate nondiscriminatory, just and reasonable rates, terms, and
conditions.

Collocation Space Several of the competing carriers we interviewed reported
difficulties in

obtaining adequate collocation space. These difficulties included
insufficient collocation space, long delays in providing space, high rates
for providing the cages (metal frames) within which competing carriers store
their facilities, and inconvenient access to collocation equipment. For
example, after an incumbent carrier reported having no space in its central
offices, the state commission found that the incumbent could convert space
that was being used for less important functions. Even when collocation
space is available, staff at a state utility commission said it takes as
long as 18 months for competing carriers to obtain collocation space.
Additionally, some competing carriers alleged that incumbents charge high
rates for collocation. Finally, competing carriers reported that incumbents
adopted policies that made it inconvenient for the competing

32 This incumbent reported that only 60 of the 440 companies with which it
has reached an interconnection agreement are actually providing local
telephone service.

companies to service their collocation equipment. For example, some
competing carriers told us that their access within central offices is so
limited that, in some cases, they cannot use restrooms, elevators, or other
facilities in the offices.

Competing carriers were collocating equipment in many incumbents' central
offices in the five states we visited. According to FCC's August 1999 report
on local telephone competition, as of the end of 1998, approximately 50
percent of the incumbents' customer telephone lines were served by central
offices where competing carriers had collocation arrangements. Incumbent
carriers told us that collocation space is expensive to prepare and
maintain. Additionally, while incumbent carriers told us that collocation
space is limited, one such carrier also described its efforts to provide
space when requested. For example, this carrier showed us space that had
been converted from a break room for employees to collocation space. Another
incumbent carrier also told us that it had made restrooms and frame rooms
available to designated employees of competing companies.

Staff at several state commissions mentioned collocation as one of the 1996
act's most difficult requirements to satisfy. Until recently, FCC allowed
incumbent carriers to require competing carriers to place their equipment in
a cage that is at least 100 square feet- specifications that competing
carriers believed increased the difficulty and cost of obtaining adequate
collocation space. Recognizing that collocation was a continuing problem for
new entrants, FCC issued new rules on March 31, 1999, that allow collocators
to share a collocation cage with other competing carriers or to install
their equipment in uncaged space. Some of the competitors with whom we spoke
believed that the new rules would improve their ability to collocate their
equipment in incumbents' central offices.

Competing Carriers FCC and state utility commissions have the primary
responsibilities for

Consider Enforcement enforcing the 1996 act. However, according to the
competing carriers we

Necessary to Open Local spoke with, the act is not being adequately
enforced. Incumbent carriers

Telephone Markets to also expressed concerns about the regulators'
implementation and

enforcement of telecommunications laws. As a result of the act, federal and
Competition

state regulators are having to adapt to changing roles, and many are taking
actions that may improve enforcement, such as resolving complaints more
quickly and adopting performance measures.

Competing Carriers Say Although many competing carriers told us that the
Telecommunications

Enforcement Is Critical to Their Act of 1996 does not need to be revised,
several said that swifter

Success enforcement of the law is needed. In particular, carriers emphasized
that

their market strategies are often contingent on their ability to enter the
market rapidly and develop a customer base. Therefore, quickly resolving the
problems that they described to us, such as difficulties in accessing an
incumbent's OSS, negotiating interconnection agreements, or obtaining
collocation space, is crucial for the successful implementation of their
business plans. Moreover, several competing carriers told us that regulators
do not impose penalties, do not assess penalties in a timely manner, or levy
penalties that are too small to influence an incumbent's behavior or fully
compensate a competing carrier for the loss of its customers.

Despite their desire for greater enforcement, many competing carriers
expressed concern about making direct complaints to enforcement authorities
because they were reluctant to jeopardize their relationships with their
only wholesale suppliers. These and other carriers were worried about losing
their retail customers if those customers were alerted to problems the
carriers were having with their primary wholesalers. Finally, some companies
did not have the time or resources to be involved in protracted regulatory
processes.

Some competing carriers noted that the process that Regional Bells must go
through to gain approval to enter the long- distance market- known as the
section 271 process- serves as an incentive for the Regional Bell Companies
to open their markets to competition. These competing carriers said that
Bell Companies seeking approval to offer long- distance service were more
responsive to the concerns of competing carriers than were other incumbents
that are already permitted to offer long- distance service in their service
regions. These competing carriers are concerned about the loss of this
incentive when the Bell Companies gain approval to enter the long- distance
market.

Incumbent Carriers Also Express The incumbent carriers we spoke with
expressed some concerns about

Concerns About Regulators' how regulators are implementing and enforcing the
Telecommunications

Implementation and Act of 1996. The incumbents were concerned primarily
about what they

Enforcement of saw as a lack of clear guidance from FCC on what the Regional
Bell

Telecommunications Laws Companies must do to pass the 14- point checklist
required for entry into

the long- distance telephone market. One incumbent carrier told us that it
thought it was in compliance with the items on the checklist only to find
that FCC considered its progress insufficient. However, FCC did not, in the

opinion of officials at this Regional Bell Company, provide adequate
guidance on what actions the company would need to take to be in compliance
with the checklist. One incumbent carrier suggested that FCC had raised the
“hurdle” over time, increasing the requirements for satisfying
the checklist. Representatives of some of these companies told us that even
today, they do not have a clear sense of what will enable their companies to
pass the checklist and gain approval to enter the longdistance market.
However, one incumbent did say that FCC's replies to applications from Bell
Companies to enter the long- distance market had provided somewhat more
detailed guidance over time.

Regulators Adapt Enforcement At the federal level, the Congress charged FCC
with implementing the local

Tools and Role to Changing competition provisions of the 1996 act. FCC has a
variety of enforcement

Market tools that can be used to implement these provisions, including, for

example, the authority to issue penalties and resolve complaints. As
previously noted, FCC also has the authority, after consultation with DOJ
and the relevant state commission, to approve an application by a Regional
Bell Company to enter the long- distance market in its local telephone
service area. 33 In addition, states and state utility commissions have
enforcement authority under the 1996 act and their own laws. In responding
to our survey, staff at some state utility commissions indicated that their
commissions had certain tools for enforcing their laws. For example, the
authority to issue civil penalties or revoke carriers' operating licenses.
Many of the states have an expedited process for handling complaints similar
to FCC's, and some other states are considering the adoption of an expedited
process. Staff at many of the state commissions believe, however, that their
authority to assess fines is not adequate to enforce the laws and
regulations that govern local telephone companies. Staff at some state
commissions said that they have no fining authority and must rely on a court
or other state agency to issue monetary penalties against a carrier or have
fining authority that is restricted to specific retail abuses.

According to FCC officials, the 1996 act has shifted the balance between
FCC's roles as an industry regulator and a market facilitator in such a way

33 FCC is required to give substantial weight to DOJ's evaluation. If FCC
determines that a Bell Operating Company has fallen out of compliance with
the competitive checklist after authority to provide in- region long-
distance service has been granted, FCC may issue an order directing the
company to correct the deficiency, impose a penalty on the company, or
suspend or revoke such authority.

that FCC now focuses more on mediating and refereeing differences among
telecommunications providers. In particular, FCC officials told us that as
telecommunications markets become more competitive, there will be less need
for FCC to regulate carriers and more demand for the agency to ensure the
efficient functioning of the market by mediating disputes and enforcing
compliance with the law. Recognizing these changes, the relevant
congressional committees recently approved FCC's plan for an enforcement
bureau to strengthen the agency's efforts to enforce the law. This plan was
implemented in November 1999. FCC officials also told us that the Commission
recognizes the need for staff training in the enforcement area. FCC has
likewise recognized the importance of swifter enforcement and has instituted
an “accelerated docket,” a formal expedited process to resolve
all forms of complaints against telecommunications carriers. 34 In addition,
FCC has used its authority to impose conditions on recent merger approvals
as a way to encourage incumbents to further remove impediments to
competition. For example, in approving the Bell Atlantic- NYNEX merger, FCC
required the merged company to improve competing carriers' access to OSS by
offering them a uniform computer interface in the states where Bell Atlantic
now operates.

According to FCC officials, under FCC's authority to approve applications by
Regional Bell Companies to enter the long- distance market in their local
telephone service areas, the Commission has spent considerable resources
clarifying the entry requirements for these companies. These officials said
that they provided early guidance on satisfying the entry requirements set
forth in the 14- point checklist in their August 1996 order implementing the
local competition provisions of the 1996 act and in their response to the
first application for entry into the long- distance market by a Bell
Company. More recently, the officials said, they addressed the requirements
for all 14 points in an October 1998 order denying Bell South's second
application to enter the long- distance market in Louisiana. And, in a
December 1999 document approving Bell Atlantic's application to enter the
long- distance market in New York, they again provided guidance for
satisfying all 14 points.

When we asked staff at the state utility commissions whether the role of the
commissions had changed since the act's passage, staff at 48 commissions
said that the role had changed, and staff at 36 of these

34 In addition to formal proceedings, regulators are also using informal
procedures to resolve many complaints.

commissions said that the role had changed greatly. Staff at some
commissions said they were doing less traditional regulation, such as rate
setting, while staff at many commissions said they were more involved in
resolving disputes among carriers. These state commission staff
characterized their roles since the act's passage as mediators, arbitrators,
and referees. In addition, staff at 31 of the 50 state commissions reported
at least some increase in the resources devoted to the regulation of
telephone service during the act's first 3 years. However, staff at 40
commissions noted that at least some increase in resources was needed to
address the increased workload that has occurred since the act's passage;
staff at 31 of these commissions said they needed a moderate or large
increase in resources.

Regulators and Carriers Believe One of the actions that regulators are
taking to better enforce laws and

Performance Measures Are regulations is to develop better information about
the services incumbents

Necessary to Ensure Compliance are providing to competing carriers. In
general, telephone companies use

“performance measures” to measure the quality of the services
they provide. For example, one performance measure might indicate how long
it takes, on average, to install a customer's telephone service. Another
measure might track the time required to repair a customer's telephone
service. Competing carriers and regulators have urged the development of
performance measures to ensure that incumbent carriers comply with the 1996
act's requirement to provide the same quality of service to competing
carriers as they provide to their own retail customers. In addition, one
senior DOJ official stated that performance measures are important for the
development of competition in local telephone markets. Similarly, staff from
40 of the state commissions claimed that performance measures were very
important for opening local markets to competition.

Performance measures are being designed to enable regulators, competing
carriers, and incumbent carriers themselves to monitor incumbents'
performance. In several of the performance measurement plans being
considered by the state commissions, monetary penalties paid to a competing
carrier are automatically imposed on an incumbent when one or more of the
performance measures indicate that the incumbent has not provided adequate
service to the competing carrier. Furthermore, some plans give state
regulators the authority to impose additional financial penalties on an
incumbent carrier that continues to provide inadequate service to its
competitors. In its December 1999 approval of Bell Atlantic's application to
enter the long- distance market in New York, FCC said that it will use the
performance measures developed in New York to monitor Bell Atlantic's
performance for at least 1 year after that company enters the

long- distance market. FCC says that if those measures fall sufficiently
below the ones submitted by Bell Atlantic when it applied to enter the
longdistance market in New York, FCC will take enforcement action, including
the possible suspension or revocation of the company's authority to offer
long- distance service in New York.

Incumbent and competing carriers hold different views on how performance
measures should be evaluated, how many are needed, and how great the
penalties should be.

Incumbents and larger competing carriers differ over which statistical
measures provide the most reliable and cost- effective information on
incumbents' performance. Smaller competing carriers are generally more
interested in whether measures of an incumbent's overall performance will
appropriately reflect the quality of the service being provided to
individual companies. The number of required performance measures varies
among the states

that have developed performance plans. Some incumbent carriers told us that
often there were more performance measures than needed to comply with the
act's requirements, while competing carriers favored additional measures to
ensure that they have adequate data to determine whether incumbents are
providing all of the required services. Incumbent and competing carriers
also had different views on

provisions in some of the performance plans that impose monetary penalties
on incumbent carriers if they do not provide required services to
competitors. Incumbents noted that the penalties in plans proposed by some
states, including annual maximums, are sufficiently high. Competing carriers
told us that the penalties in several of these plans are not high enough to
encourage compliance with the performance standards and deter misconduct.

Observations The Telecommunications Act of 1996 fundamentally changed the
laws and regulations governing the telecommunications industry. However,
some of

the companies and regulators we spoke with noted, as did the Supreme Court,
that the act was not entirely clear about how some provisions were to be
implemented. In the 4 years since the act was passed, regulatory actions and
court decisions have clarified some of these issues, while others are
awaiting resolution or clarification. During the same 4 years, an array of
companies- both incumbents and new competing carriers- have spent
considerable resources responding to the incentives and obligations

created by the act. They have pursued new business plans, developed new
technologies, invested in new facilities, adapted existing facilities,
restructured their businesses through mergers, and otherwise refocused their
companies toward the future. Thus, the time since the act's passage has
constituted a necessary period of adjustment, for regulators and companies
alike.

Given the many changes that have taken place and are ongoing, it is
difficult to determine whether the degree of competition that has emerged in
local telephone markets thus far should be viewed as disappointing or as
about what should have been expected. Moreover, the market for local
telephone service is continuing to evolve. For example, some forms of
communication, such as mobile wireless telephone service and electronic
mail, are already being substituted at times for traditional voice telephone
service, and the Internet may soon provide further alternatives. Most
important, the carriers we spoke with noted that customers are increasingly
influenced in their selection of local telephone service providers by
whether carriers can also provide other telecommunications services, such as
long- distance service and Internet access. That is, consumers now focus
less on purchasing individual telecommunications services and give more
attention to simultaneously purchasing a package of these services. This
packaging is thus blurring the traditional distinctions among
telecommunications services and among providers, as firms that once provided
only certain services broaden their market offerings. Understanding this
trend is important for analyzing the further development of competition
throughout this industry. As the marketplace continues to change, one of the
many remaining challenges for regulators and the Congress will be to obtain
the information needed to measure and track the development of competition.

Agency Comments We provided a draft of this report to the Federal
Communications Commission (FCC) and to the Department of Justice (DOJ) for
review and

comment. DOJ officials did not have any comments on this report. FCC
officials, including the Associate Chief, Common Carrier Bureau, provided
oral comments to us. They stated that that they had no significant
disagreement with the overall findings and conclusions of the report. In
addition, they provided a variety of technical clarifications and comments
that we incorporated as appropriate.

We conducted our review from April 1999 through December 1999 in accordance
with generally accepted government auditing standards. For more information
on our scope and methodology, see appendix I.

As agreed with your offices, unless you publicly release its contents
earlier, we plan no further distribution of this report until 14 days after
the date of this letter. At that time, we will send copies of this report to
interested congressional committees; the Honorable William E. Kennard,
Chairman, Federal Communications Commission; the Honorable Joel Klein,
Assistant Attorney General, Antitrust, Department of Justice; and other
interested parties. We will also make copies available to others on request.

If you or your staff have any questions about this report, please contact me
at (202) 512- 7631. Key contributors to this report are listed in appendix
III.

Stanley J. Czerwinski Associate Director, Housing, Community Development,
and Telecommunications Issues

Appendi Appendi xes xI

Objectives, Scope, and Methodology To obtain information about competition
in local telephone markets, the Chairman and the Ranking Minority Member of
the Subcommittee on Antitrust, Business Rights, and Competition, Senate
Committee on the Judiciary, asked us to conduct a study on emerging
competition in local telephone markets. In response to this request, we
analyzed (1) the development of competition in local telephone markets and
the market strategies employed by new carriers in five states under the 1996
Telecommunications Act, and (2) the key issues affecting that development
and the enforcement activities of federal and state regulators to address
those issues. To obtain information about how competition is developing in
local telephone markets, we visited five states- California, Illinois, New
York, South Carolina, and Texas- that had varying demographic and telephone
usage characteristics (see table 1). We chose these states because they
varied by the date when competing carriers first entered the marketplace,
contained urban and rural areas, varied in the status of the Bell Company's
application for entry into the long- distance market, and had public service
commissions with different focuses. In addition, these were among the states
recommended by trade association officials and other experts whom we asked
for recommendations.

Table 1: Income and Telephone Data for the Five Selected States Criterion
California Illinois New York South Carolina Texas

Median household income in 1998 $40, 934 $43,178 $37,394 $33, 267 $35, 783
Percentage of households with telephone service in July 1999 96.5% 91. 7%
95. 4% 91. 1% 93.5%

Total number of telephone lines as of December 1998 (in thousands) 22,222 8,
209 12,844 2, 248 12, 617

Percentage of total state lines provided to competing carriers for resale as
of December 1998 1.4% 2. 4% 1. 9% 2.6% 3.0%

Percentage of resold lines provided by large incumbent carriers serving
residences as of December 1998 51.5% 42. 6% 23. 8% 59. 3% 59.4%

Percentage of total U. S. telephone revenue in 1997 11.8% 4. 4% 7. 4% 1.3%
6.9%

Sources: These data were the most recent available. The median household
income numbers are from the U. S. Bureau of the Census, State and
Metropolitan Area Data Book 1997- 98; the remaining information is based on
data in FCC's Trends in Telephone Service( Sept. 1999).

In these five states, we interviewed and collected information from
officials of the Regional Bell Companies and other incumbent carriers, state
public utility commissions, and 24 competing carriers. We chose the
competing carriers by talking to experts and officials at state utility
commissions. In each state, we attempted to identify competing carriers that
served different markets and used different technologies to deliver local
telephone service. To gain information about how competition is evolving
more broadly and how well state officials feel they are able to implement
the 1996 act, we mailed surveys to staff at the public utility commissions
of all 50 states and received responses from all of them. The survey was
sent to staff members who were charged with ensuring that knowledgeable
staffers completed it. To ensure that all commissions participated in the
survey and that we fully understood the answers to our questions, we
telephoned all 50 state public utility commissions to pose follow- up
questions and record all survey responses. In addition, some state
commissions provided written responses by mail. The survey administered to
the Alaska and Hawaii commissions differed from the one administered to the
other 48 commissions because Alaska and Hawaii do not have Regional Bell
Companies and, therefore, some of the questions were not applicable. Because
we did not speak to commissioners, the survey responses represent the views
of commission staff. See appendix II for the survey responses.

To identify the key issues affecting the development of competition and the
enforcement activities of federal and state regulators to address those
issues, we interviewed and collected information from officials at the
Regional Bell Companies and other incumbent carriers, the state public
utility commissions, and competing carriers in the selected states. We also
used, as appropriate, information from our surveys of the state public
utility commissions. In addition, we interviewed officials at and gathered
information about FCC, DOJ, trade associations, and other experts. Moreover,
we conducted literature searches and legal and regulatory research related
to relevant federal and state legislation and legal documents.

Responses to Survey of State Utility

Appendi xII

Commissions Note: Numbers show the number of commissions selecting each
response.

Some questions were not answered by all respondents and therefore totals do
not necesarily add to 50 states.

Appendi xI II

GAO Contacts and Staff Acknowledgments GAO Contacts Stanley J. Czerwinski
(202) 512- 7631 Amy Abramowitz (202) 512- 4936 Acknowledgments In addition
to those named above, Dennis Amari, Nancy Barry, Elizabeth

Eisenstadt, Thomas Farrell, Fran Featherston, Jennifer McCarthy, Myrna
Pï¿½rez, and Mindi Weisenbloom made key contributions to this report.

(385793) Lett er

GAO United States General Accounting Office

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Contents Letter 3 Appendixes Appendix I: Objectives, Scope, and Methodology
36

Appendix II: Responses to Survey of State Utility Commissions 38 Appendix
III: GAO Contacts and Staff Acknowledgments 57

Tables Table 1: Income and Telephone Data for the Five Selected States 36
Figures Figure 1: Market Shares of the Local Telephone Market, by Type of
Carrier

14 Figure 2: Growth in the Number of Access Lines Served by Competing

Carriers, 1997- 98 15

Abbreviations

AT& T American Telephone and Telegraph DOJ Department of Justice FCC Federal
Communications Commission LATA local access and transport area OSS
operations support systems UNE unbundled network element

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Appendix I

Appendix I Objectives, Scope, and Methodology

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Appendix II

Appendix II Responses to Survey of State Utility Commissions

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Appendix II Responses to Survey of State Utility Commissions

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Appendix III

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Appendix III GAO Contacts and Staff Acknowledgments

Page 59 GAO/ RCED- 00- 38 Competition in Local Telephone Markets

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