Dana R. Williams, LBJ School of Public Affairs, University of Texas at Austin

"Texas Telecommunications Deregulation: Its Effects and Its Future"

December 3, 1998

One of the latest waves of deregulation in industry to hit the United States involved the telecommunications sector. The years 1995-1996 marked the greatest changes in the industry since the AT&T breakup of 1984. This paper examines how deregulation happened in Texas, what its effect was, and what changes in the deregulation scheme may be forthcoming.

Before Deregulation

As the 1995 legislative session began, local telephone service in Texas was dominated by Southwestern Bell (SWB), which controlled 75% of the 9.9 million telephone lines. GTE and its share of 1.4 million lines was a distant second in the market, followed by 59 other, smaller companies, including telephone cooperatives formed of necessity in extremely rural areas. Competition was nonexistent, and Southwestern Bell, GTE, and the other companies each held monopolies in their respective service areas. In these kind of market conditions, telecommunications deregulation appeared on the scene in Texas.

House Bill 2128

House Bill 2128, the state telecommunications deregulation bill, was passed by the 74th Texas Legislature and enacted on September 1, 1995, as the Public Utility Regulatory Act of 1995. The bill was a part of the nationwide trend in state telecommunications deregulation. In just the five month period January &emdash; May, 1995, ten states, including Texas, passed laws designed to abolish local telephone service monopolies and establish price-based alternatives to traditional earnings-based regulation of telephone companies. In general, the state laws were kind to the incumbent local-exchange carriers, most of which are Baby Bells, even though the laws purported to throw open competition in local telephone markets.

Lawmakers envisioned three goals for HB 2128: allow for a competitive telecommunications market, encourage investment in the state, and provide a world class telecommunications infrastructure in Texas.

Provisions implementing the primary goal of HB 2128 in Texas were designed to open competition for local service in order to both keep rates down and generate new services, such as high-speed Internet access. Lawmakers envisioned the bill opening the first cracks in the local telephone monopolies and competitors then driving in wedges of lower prices or more services in hopes of getting blocks of customers for themselves. Southwestern Bell, though, viewed the bill favorably, and Wall Street investment firms predicted SWB’s bottom line would suffer little damage because the bill hampers entry into the market for would-be competitors. Critics who declare the bill weak in encouraging competition have even called HB 2128 the "Defense of Southwestern Bell Act."

Major Provisions of HB 2128

HB 2128 was a significant and wide-ranging revamping of the state telecommunications laws. The most important provisions allow for the introduction of competition in the Texas local telecom market. As a result, cable companies such as Time Warner are now allowed to enter the local telephone markets, local telephone companies are permitted entry into cable markets, long distance carriers such as MCI and AT&T can jump into local service, and so son. In designing the bill, lawmakers envisioned, for example, a company like the cable television provider Time Warner offering a combination of services as a package deal encompassing phone, cable, and Internet service. However, while the legislation blurs the lines between and entry access to various telecommunications market segments, the bill also restricts municipality involvement in telecommunications with prohibitions on partnering with telephone companies to provide local service.

How Local Service Competition Would Work

Those companies wanting to sell local telephone service would have to apply to the Public Utility Commission (PUC) for permission to do so. A potential new entrant to the market would make a decision on whether to build its own network or rely on buying access to the existing telephone network from the incumbent phone company (usually Southwestern Bell) and reselling service. Resale, as the latter type of service is called, is best suited for companies wanting to serve limited areas.

A Service Provider Certificate of Authority (SPCOA) would be granted for a company wishing to resell local services but not provide access or toll services, while established facilities-based competitive local providers could receive a Certificate of Operating Authority (COA). According to Leslie Kjellstrand, Director of Public Information at the PUC, the COA licensing scheme was designed to prevent AT&T, MCI WorldCom, and Sprint from dominating the local resale markets. The bill requires COA holders, which include the large long-distance companies, to build their own networks over a six year period for most of their service area. According to the bill sponsor, Representative Curtis Seidlits, the buildout provisions, as they are called, were developed in order to discourage "cherry-picking" or "cream-skimming," in which new competitors seek out only the most profitable customers in dense commercial areas, such as businesses, while ignoring residential customers who are usually more dispersed geographically. The bill requires, then, that companies who build their own networks only use resale for up to 40 percent of their service area, and that the service area must have a radius of at least 3 miles (roughly a 28 square mile area). Long distance giants AT&T and MCI WorldCom believe that the 40 percent limit on resale effectively bars them from entering the local service market in Texas, and AT&T has estimated that it would cost as much as $500 million in Austin alone just to match the minimum building required to replicate 60% of Southwestern Bell’s network. Because of the network building provisions, cable television companies may have an easier time entering the market because they already have networks in place, though the networks are not yet ready for two-way communication.

Access Charges

Local telephone companies maintain that local residential telephone service is subsidized by long-distance access charges, though consumer groups dispute this idea, saying that this has never been proven by the local carriers. Access charges are fees paid by long-distance companies to local telephone companies to complete a call. HB 2128 effectively froze access charges at 12 cents until September 1, 1999.

Local Rates Cap

One great victory for Southwestern Bell in HB 2128 was the inclusion of the "incentive regulation" option for companies who elect to take it. In this plan, electing companies, including Southwestern Bell, have their rates capped until September 1, 1999, but in exchange escape any further restrictions or regulations on profit. This means that if a local service provider can lower its expenses while rates are capped, profits will grow without any repercussions from the PUC. This plan is exactly what Southwestern Bell has been seeking for some time. SWB argues that having a chance at higher profits will give it more incentive to increase investment in its infrastructure in Texas.

Competitive Safeguards

The competitive safeguards in HB 2128, though criticized by some as being too weak, were designed to prevent Southwestern Bell from keeping competitors out of the market with its economic muscle, even as the legal barriers to competition are dropped. HB 2128 safeguards are comprised of the following:

  • prohibition against bundling of services resold to competitors - incumbent telephone companies cannot require competitors to buy all of its services.
  • provision for number portability &emdash; consumers who change telephone companies are allowed to keep the same telephone number.
  • requirement for interconnection of different telephone networks &emdash; networks of the various different telephone companies must connect and be able to work together.
  • resale rate &emdash; the Public Utility Commission (PUC) must set the resale rate charged to a reseller of phone service ( a company who leases lines from the incumbent telephone company and resells the service) only high enough for the equipment owner to recover costs.
  • imputation provision &emdash; a local telephone company cannot charge a competitor more for a service than that company charges its own customers for the service.
  • non-discrimination provision &emdash; the incumbent local telephone company cannot refuse or delay interconnections with a competitor’s network, refuse a competitor access to the original network, degrade the quality of the connection or take any other action to hurt the newcomer.
  • costing and pricing provisions &emdash; the PUC determines how much telecommunications services cost and how they are priced. Monopoly services must "remain affordable" and prices for competitive services must not be "predatory" or subsidized by monopoly services.

Long-Distance Pay Phone Rates

Another provision of the law regulates long-distance pay phone charges by placing caps on rates in order to address the problem of price-gouging on long-distance pay phone charges. According to industry sources, some pay-phone owners have hit consumers with charges as high as $7-8 for a one-minute long-distance call. HB 2128 requires that the price of pay-phone long-distance calls not exceed $4.20 for the first minute and 29 cents for each following minute.

Infrastructure Improvement

In order to advance the HB 2128 goal of promoting the development of a world class telecommunications infrastructure in Texas, lawmakers devised five major provisions to that end. First, minimum service standards were designed in order to ensure a minimum level of voice grade service throughout Texas. This provision requires all local service providers to ensure that all of their customers have by December 31, 2000, access to single party service, tone-dialing service, basic customer calling features such as call waiting and call forwarding, choice of long distance carrier without having to use an access code, and digital switching capability in all exchanges if requested by a customer. This last point was included because any data transmission over telephone lines requires digital switching capabilities.

Section 3.358 of PURA 95 details the second infrastructure provision, relating to infrastructure commitment of "incentive regulation" companies. Local providers who elect "incentive regulation," a more relaxed form of regulation than that which existed before 2128’s passage, must make some investments in infrastructure upgrades relating to digital capabilities, broadband technologies to support high-speed services, and other improvements.

The third provision details infrastructure commitments to certain public entities by companies who elect "incentive regulation." This provision requires electing companies to establish a telecommunications infrastructure that connects public entities such as schools, libraries, non-profit telemedicine centers, and public hospitals. Also, priority is given to rural areas, areas designated as critically underserved, and to medical or educational institutions that serve high percentages of economically disadvantaged persons. Many of these infrastructure services must be priced at no higher than 105% of the providing company’s cost.

The fourth infrastructure provision allows smaller local service providers serving less than 5% of the access lines in Texas to elect less regulation in exchange for infrastructure investments and discounted rates. The fifth and final major provision relating to infrastructure in HB 2128 creates the Telecommunications Infrastructure Fund (TIF), designed to provide grants and loans to public entities to purchase equipment and to pay for wiring, materials, and other related costs. The goal of this provision is to get digital and Internet services to schools, libraries, and public medical institutions. TIF is funded by a 1.6% tax on gross revenues for telecommunication services, excluding cellular and Internet services. Cellular and Internet services were deemed exempt after a lawsuit brought to court by the cellular and Internet service provider companies. The fund will raise $1.5 billion over the ten year period it exists and is the largest telecommunications infrastructure fund in the United States.

Federal Telecommunications Act of 1996 (FTA ’96)

The Federal Telecommunications Act passed by Congress in 1996 has changed the picture of telecommunications deregulation in Texas. The law introduced local competition on a nationwide basis and established requirements for Bell companies to get back into the long distance business. The Bells have been prohibited from all but intraLATA long distance business since the AT&T divestiture in 1984. FTA ’96 allows a much freer competitive environment than Southwestern Bell had dreamed of since the passage of HB 2128.

The Federal Communications Commission (FCC) has made rulings based on FTA ’96 in order to address areas of conflict or overlap between state deregulation laws and the federal legislation. In Texas, incumbent local exchange carriers were required to sell access to their networks to competitors at only a 5% discount off retail rates paid by consumers. FCC rulings since HB 2128 require that incumbents sell access to their networks at a much larger 25-35% discount off retail rates. To Southwestern Bell’s great displeasure, in September, 1997, the FCC also ruled that the 27 mile buildout provisions of HB 2128 for holders of a Certificate of Operating Authority are pre-empted by the FTA and therefore no longer valid. This ruling was designed to make it much easier for competitors to enter the local service market in Texas.

FTA ’96 also established new guidelines for the timing of entrance into long distance markets by the Baby Bells. Southwestern Bell, then, cannot enter the long distance market until its local markets are considered sufficiently competitive, according to a 14-point checklist delineated in the federal law. The PUC and the Legislature hold most of the authority to determine when and if the checklist points have been met by Texas incumbent local exchange carriers.

Current Situation

PUC Activities Since Deregulation

Since HB 2128 passed in 1995, the PUC has certified more than 225 new entrants to compete in Texas local telecommunications markets. Well over half of these entrants have been issued the Service Provider Certificate of Authority (SPCOA), which requires them to show that they have the technical and financial qualifications to provide local service but does not require them to have a network already built in Texas. However, Suzanne Bertin of the PUC says that many of these new SPCOA holders are companies who target consumers who have been disconnected by Southwestern Bell or other incumbents as a result of failure to pay their bills. The PUC has also approved roughly 300 interconnection agreements between incumbent and new providers. Most of these agreements were negotiated by the participating companies, but some have had to be arbitrated by the PUC.

The PUC has also since 1995 developed numerous rules to implement HB 2128 and relevant FTA ’96 legislation. This includes the still-ongoing, massive task of overhauling Texas’ universal service program in order to comply with both HB 2128 and FTA ’96. Additionally, the PUC is currently involved in a collaborative process with Southwestern Bell to ensure that it meets the requirements of the FTA ’96 competitive checklist prior to asking for FCC approval for entrance into the long distance market in Texas. Finally, the PUC is also addressing other competitive issues such as area code exhaustion, allegations of anticompetitive behavior, and consumer protection issues such as "slamming" and "cramming." Slamming occurs when a consumer’s long distance carrier is changed against the consumer’s will and without his or her knowledge by another company. Cramming refers to charges on consumer phone bills that are unauthorized and are placed on the bill by unscrupulous telephone companies with access to the incumbent company’s billing system.

Competition Delayed

Most Texans still do not have real choice in local telephone providers. What little competition for local service exists primarily targets business customers. The residential competitors consist primarily of resellers whose target market is those consumers disconnected by the incumbent provider for unpaid bills. Competition at the local level is steadily but slowly increasing, though. In general, prices for local services have stayed the same or have gone up since 1995. Also, Southwestern Bell still has about 75% of the local market in Texas, even though competitors in Texas have leased 320,000 phone lines at wholesale rates from Southwestern Bell in order to resell service to their own customers.

Instead of new entrants and more competition for local service, mergers nationwide between telephone companies have been occurring instead. Cream-skimming appears to be in full swing, as well. Time Warner and ChoiceCom both maintain telephone networks in Austin only for their business customers, while MCI is rolling out local service for businesses but not residential customers in San Antonio. Not much improvement has been made regarding new services and technologies that competition was supposed to encourage, either. As the Austin-American Statesman put it in an editorial entitled "Stuck on Hold," "the speed of home Internet access is lagging behind the possible."

One roadblock to competition deals with interconnection issues. Difficulties with interconnection have arisen both with regards to connecting calls between different telephone networks and in processing orders to change companies. Also, the different phone companies have different hardware and software, including operating systems, that must be made to work together. Delays have also been caused by slow movement of the FCC on rulings regarding enforcement of interconnection agreements. The extremely high costs of building networks has discouraged many potential competitors, and some competitors feel that the profit margins on resale service are too slim to make market entry worthwhile. Finally, administrative and legal battles have slowed down implementation of HB 2128 and FTA '96, further slowing the transition to local service competition in Texas.

Although lawmakers, consumers, and industry players generally agree that competition in local markets is limited, they also tend to believe that the market and not HB 2128 is the underlying problem. Most of these people feel that the law is fine mostly as it is, and that with a few minor changes it can still work to bring local service competition to Texas. In fact, the Senate Interim Committee on Economic Development’s Report on Telecommunications and Insurance declares,

"The Committee is unable to identify any statutory barriers to the development of competition in the Texas telecommunications market. Upon completion of its study, the Committee deems that the PUC has all the tools required to develop and implement the goals of HB 2128, 74th Legislature…. the committee does not make any recommendations for legislative action at this time."

Access Charges

Access charges amount to about $800 million in revenues a year for Southwestern Bell. David Cole, president of Southwestern Bell-Texas, says "the $800 million from high access charges keeps monthly bills for local service affordable because the price for local residential service is ‘way too low’ compared to costs." Long distance companies and consumer groups dispute this "subsidy" idea and claim that the 12 cent rate should be cut since they believe it costs Southwestern Bell less than 1 cent a minute to complete long-distance calls. Access charges are frozen at 12 cents until September 1, 1999, but the PUC has already promised to look into the access charge situation and possibly initiate a rate case against Southwestern Bell once the cap expires next year. Also, a recent PUC staff study found that Southwestern Bell in 1997 earned $288 million more than it would have been allowed to earn if its profits were still regulated as they had been before HB 2128. This "overearning" means that had it not been for HB 2128 ending profit regulation, there would definitely have been rate cuts considered by the PUC. All of this gives more ammunition to those such as the PUC and the long-distance companies who believe that access charges are priced too high and that local rates would not have to rise if access charges were slashed.

As is stands now, Southwestern Bell wants the Legislature to extend a freeze on the access charge for another two years, while long-distance companies want it to expire as scheduled September 1, 1999.

The Upcoming Legislative Session

It appears certain that some kind of telecommunications "clean-up" bill will be introduced in the 1999 session. In fact, Senator David Sibley, chair of the Senate Economic Development Committee, which usually handles telecommunications issues in the Senate, has stated publicly that there will be some kind of bill intended to rectify the disconnects between the old regulatory scene and the new, competitive scenario. Ivan Friedman, Committee Clerk for the House of Representatives State Affairs Committee, believes that Southwestern Bell also supports a HB 2128 cleanup bill in order to fix the provisions of 2128 that it perceives to be unfavorable. According to Friedman, the long-distance carriers also would like to see a cleanup bill in order to rectify problems in 2128 they feel were unfavorable, such as the 12 cent access charge.

According to legislative staffers, regulators, and lobbyists interviewed for this paper, the hottest telecommunications issues in the next session will probably deal with the rate cap, access charges, and consumer protection.

The biggest issue the Legislature must deal with concerning rate caps is what to do when the rate cap expires in September, 1999. With HB 2128, rates for local service were capped for electing service providers, including Southwestern Bell and GTE, for four years. The rate cap issue is the one over which Southwestern Bell and the PUC are most at odds. Southwestern Bell wants the rate cap extended to September 1, 2001, because they fear that the PUC has authority to initiate a rate case after expiration of the cap. The case would most likely result in a lowering of rates for local service, something these incumbent carriers would not greet with pleasure. Janee Briesemeister, Senior Policy Analyst for the Southwest Regional Office of Consumers Union, says that Consumers Union would like to see the cap extended. One legislative staffer interviewed commented that the rate cap issue is somewhat open to interpretation. Whether the rate cap comes off in September, 1999, or is extended must be decided by affirmative action by the Legislature this session, according to the staffer.

"The access charge issue is the big, hairy one," added the staffer, "and the long distance companies are shooting for it this session." The long-distance companies would like the access charge that they pay to local service providers for completion of long-distance calls reduced. To that end, they are advocating making a change in the law that would allow a proceeding to be held at the PUC to reduce the access charge.Janee Briesemeister of Consumers Union would like to see a rate case started by the PUC to determine what portion of access charges actually goes to subsidize basic service rates. Consumers Union believes that access charges can be lowered without necessarily increasing monthly bills for local service.

The third major topic relating to telecommunications to be addressed during the next session deals with consumer protection. The issue of "slamming" was handled by the Legislature last session, so the scam most likely to garner legislative attention this time around is "cramming," which occurs when a company slips a charge onto a customer’s bill either mistakenly or fraudulently. This has become a problem recently because under FTA ’96, local phone companies act as clearinghouses to forward bills from new entrant companies which provide a wide range of services. Competitors, then, have for the first time access to the billing network of the incumbent local exchange carrier. This provision under FTA was designed to avoid costly duplication of technical and business systems when new competitors enter a market.

One bill on the "cramming" issue has already been prefiled for the next legislative session. Janee Briesemeister finds this "scam-of-the-session" approach to solving consumer protection issues inefficient, though. The Consumers Union would like to see a bill passed giving authority to the PUC to handle this kind of consumer ripoff so that consumers do not have to wait for the Legislature, which convenes only once every two years, to take action on this type of issue. The PUC could then address scams as they come up at any point in time with the expanded authority. Finally, legislation may be introduced in the next session to make bills more readable and consumer-friendly, according to Ivan Friedman.

Beyond the three major potential topics of legislation mentioned above, there are a few other issues which may be brought up in the Legislature in 1999. One legislative staffer mentioned that there is talk of a possible bill introducing the idea of combining the COA and SPCOA designations and no longer differentiating between the two types. The staffer also mentioned that some concerned parties are wondering if the PUC should have authority to revoke a SPCOA or otherwise penalize an SPCOA holder for noncompliance for PUC rules. As the law stands now, the PUC has authority over incumbent providers but little over the SPCOA companies. Finally, another issue being discussed currently in the Legislature is whether or not distinctions between voice and data traffic should be eliminated in PURA. Lawmakers realize that data rather than voice transmissions are becoming more important as the telecommunications industry evolves, but the current regulatory scheme which distinguishes between data and voice, which is really just another type of data, may be outdated.

Prospects for Change

Persons the author interviewed in the course of this research seemed quite unsure about the possibilities of any of this potential legislation actually becoming law. The incredible lobbying and financial strength of Southwestern Bell will make the company a heavyweight player in the next session, but the long-distance companies, the potential local competitors, and consumers’ groups also have some strength and support. Legislative staffers indicated that lawmakers are just as divided over issues as the industry giants, and in general they felt that they could not predict what might happen beyond saying that something will happen. Telecommunications may be becoming one of those issues that lawmakers touch up and rework every session.

Dana Williams is a candidate for the master's degree in public affairs at the LBJ School of Public Affairs at the University of Texas at Austin.