FCC Chairman Wheeler’s plan to extend a new rate regulation regime to so-called business data services (which provide point-to-point transmission of data at guaranteed speeds and service levels), formerly known as “special access” services, is one step closer to reality following the Commission’s recent adoption of an Order and Further Notice of Proposed Rulemaking (“FNPRM”) on May 2, 2016.  The item puts forward a proposed framework for potentially regulating the rates for such services in those markets deemed to be “non-competitive.”  If adopted, this regime would impose a complex and unwieldy set of rules designed to regulate rates for business data services, or what Commissioner O’Rielly described as “plain old rate regulation” –precisely the kind of ex ante rate regulation Chairman Wheeler had previously rejected in other proceedings.    

The FNPRM, like many other controversial proposals voted on in recent months, was approved on partisan lines with both Republican Commissioners strongly dissenting to an item they believe is a step backwards.  Indeed, Commissioner O’Rielly claimed that the proposal represents a “radical a departure … from history and precedent” and ignores the record of increased competition and lower prices. Commissioner O’Rielly also noted that

This may be labeled a Further Notice but it seems pretty clear that the outcome is predetermined. As a preview of things to come, this final version has significantly walked back earlier suggestions that markets could be defined in rational ways and that at least some could be found to be competitive.

Comments on the proposal are due June 28, 2016, and reply comments are due on July 26, 2016.

  I.   Executive Summary

The FNPRM outlines a new proposed framework to regulate business data services and sets forth proposals for defining competitive and non-competitive markets and products.  Although framed as a proposed rulemaking, the Commission did not include any proposed rules in the item.  Instead, the FNPRM raises numerous questions focused on how to regulate these services, and seeks comment on the issues raised.  However, the Commission does make several important preliminary conclusions, including the following:

• Circuit-switched business data services (DS1 and DS3 connections), usually called time-division multiplexing (TDM) services, are less competitive.
• Packet-based business data services (including Ethernet connections) offered at speeds of 50 Mbps, or above, “tend to be” more competitive than the supply of business data services with lower bandwidths.
• Best efforts broadband Internet access service is not a product substitute for business data services and is not subject to the proposed new rate regulation regime.
• The appropriate geographic market for evaluating the presence of competitive services is an area larger than a census block, but smaller than an MSA.
• Potential regulation of the rates and terms of business data services in non-competitive markets would be achieved through the use of an “anchor pricing” system that would use presumptively reasonable rates for similar services as a benchmark to determine the reasonableness of business data services.

In addition, the item also includes an order prohibiting certain ILEC tariff terms and provisions, including: 1) so-called “all or nothing” provisions; 2) shortfall penalties; and, 3) unreasonable early termination penalties.

II.    Competition Analysis

Having reviewed a number of econometric analyses submitted on behalf of industry stakeholders and its own independently retained expert, the Commission draws a number of tentative conclusions about the nature of business data services competition and seeks further comment.  At a more fundamental level, the item is driven by the Commission’s conclusion that competition for business data services is “uneven” across places and products.  The Commission also seeks comment on its approach to defining the relevant underlying market segments upon which it bases its tentative conclusions and proposed regulatory framework. 

A.. Market Definitions

i. Product Markets

A. In defining the relevant product markets within the larger business data services market, the Commission seeks comments on its belief that best efforts Ethernet over DOCSIS 3.1 provided by cable companies is not a substitute for traditional business data services service.  This belief is based on both the significant price differential and differences in functionality and guaranteed reliability, suggesting that customers view these as distinct products.  On the other hand, the Commission finds that, despite differences in scalability, packet-switched business data services places competitive pressure on TDM business data services, while noting that customers face high costs of switching providers. 

In addition, the Commission finds that the supply of business data services with a bandwidth in excess of 50 Mbps “tends to be” more competitive than the supply of business data services with lower bandwidths.  Indeed, recognizing that cable providers are often the competitive new entrants to many markets, what the FCC called a “great success story,” the item nonetheless adopts a framework for imposing rate regulations on the very same companies that have introduced high-capacity services to many markets.

This apparent dichotomy reflects (at least in part) efforts by Commissioner Clyburn to move the Commission away from a preliminary conclusion that the market for such services is, indeed, competitive (thereby leaving such services largely unregulated).  According to press reports Commissioner Clyburn convinced the Chairman to moderate a preliminary finding that packet-based Ethernet services of 50 Mbps, and above, like those offered by many cable operators, are competitive.  As a result, packet-based services above 50 Mbps are likely to be subject to competitive analysis (and potential regulation) on a market-by-market basis.                                                          

ii.  Customer Markets

At a high level, the Commission recognizes distinct retail purchaser and carrier purchaser customer markets.  Within the retail purchaser market, the Commission seeks comment on its tentative finding that multi-location purchasers (i.e., enterprise customers) may form a distinct customer market.  The Commission notes that competition in dense geographic areas does not constrain pricing options for these customers for their locations in less dense areas with lower bandwidth requirements.

While recognizing that there may be limited competitive business data services alternatives for carrier purchasers, the Commission seeks comment on whether such customers have countervailing power even when dealing with an entity that may otherwise have market power, and whether they need different protections than end users.                                                       

iii.  Geographic Markets

Using a supply-side substitution test, which looks at the competitive pressure on price exerted when competitor facilities are within a distance that allows for economical provision of service to a customer location, the Commission concludes that the business data services geographic market is significantly smaller than an MSA, the foundation for the existing regulation of certain TDM-based services.  However, the Commission believes the relevant geographic market likely extends beyond the area of the average census block.  The Commission does not, however, land on a specific geographic market area, instead calling for comment on how close competition must be to place material competitive pressure on supply at a given location, and whether the distance may vary with the nature, most notably the bandwidth level, of the business data services in question. 

The Commission also notes that it does not yet know how much competitive pressure different forms of supply place on suppliers, or how many suppliers are sufficient to make prices effectively competitive.  At the same time, the item does acknowledge that the presence of potential competitors can constrain rates, at least in certain circumstances:

Potential competition is important, that is, nearby suppliers can constrain [business data service] prices. For example, we find that fiber-based competitive supply within at least half a mile generally has a material effect on prices of [business data service] with bandwidths of 50 Mbps or less …

Notably, on several significant matters the Commission does not express even initial views, but seek commenters’ views, including:

• How many competitive choices are necessary to ensure supply is materially competitive, and does the identity of the competing suppliers matter, and does this vary by the type of BDS in question?
• How important is potential competition to this analysis? Does facility-based competitive supply beyond half a mile have a material effect on prices of BDS?
• Do the effects of competitive facility-based supply on prices vary by the specific type of supply (for example, whether the supplier actively sells service nearby or just has a fiber network nearby, or whether the supplier uses HFC or leases dark fiber or UNEs)?

III.    Proposed “Anchor” Pricing Regime in “Non-Competitive” Markets

In those markets deemed to be “non-competitive” the FCC proposes to adopt an “anchor” pricing, or benchmark, rate regulation scheme intended to ensure that packet-based business data services which are not subject to price cap regulation (everything but DS1 and DS3 services) are just and reasonable.  The Commission presents three potential approaches, and tentatively concludes that the third approach is best suited for its objectives.

“Anchor” or Benchmark Pricing Proposals

1. Under the first option the Commission would rely on regulated TDM service prices to anchor the prices of similar packet services.
2. The second option would require the Commission to adopt one regulated rate for packet-based business data services.  For example, the Commission suggests that it could establish a regulated rate for a 10 Mbps Ethernet service, which could serve as an anchor for nearby-bandwidth packet-based business data services, and could arguably constrain those rates.

3. The final option raised by the Commission is to initially use reasonably comparable prices for regulated TDM services as a benchmark to help the Commission determine whether rates for various packet-based business data services are just and reasonable.  Then, “over time” the Commission would shift its “regulated” benchmark rates to packet-based business data services rates that are adopted under this approach to determine whether packet-based business data services rates are just and reasonable.

In evaluating these options the Commission tentatively concludes that the third option is the preferred approach, in part because it mirrors the rate regulation regime used by the Commission in the recent Emerging Wireline Order. 

Methodology for Evaluating Rates Under Anchor-based Pricing - The Commission’s anchor-based pricing proposal raises many questions, most of which the Commission has yet to answer itself.  Accordingly, the item requests comments on how such an anchor pricing regime might work in practice.

As a baseline, we know that the Commission proposes to use as a benchmark for evaluating just and reasonable packet-based business data services rates the price of the most comparable legacy TDM service, regardless of the fact that the services may be provided using different technology platforms.  The Commission contemplates that once those initial benchmarks are established, and as TDM services are discontinued over time, the presumptive rates for these benchmarked packet-based business data services would serve as a continuing benchmark.  The Commission provides an example of one potential methodology it might use in evaluating rates under this approach:

The anchor price for a particular market for a 5 Mbps Ethernet service would be the cost of the closest TDM equivalent offered by the incumbent LEC, which, for example, might be a DS1. This would not imply that the price of the Ethernet service should be the same as that of the nearest equivalent service, but only that the Commission would judge whether the 5 Mbps service price was just and reasonable in the light of the DS1 price. In this example, the Commission could determine that the 5 Mbps service price should not exceed the price of the DS1 multiplied by 3.3 (= 5/1.5), given the prices of higher bandwidth services usually fall more than proportionately with bandwidth, and that Ethernet services are considered to have a lower cost in supply than legacy TDM services.

At the same time, the Commission asks numerous practical questions about the feasibility of this approach; whether it is “workable;” whether it can be employed when no comparable TDM service exists; whether rates should differ based on geography, service tier or technology used; whether this regime should be a hard “ceiling” for rates, or merely an indicator for the Commission to evaluate whether the rates are just and reasonable; and, whether this anchor price approach would be workable.

Recognizing the need for rates to adjust over time, the Commission acknowledges that anchor or benchmarked prices must adjust to changes in economic conditions and advancements in technology and productivity that impact the costs of providing services.  Anticipating such changes, the Commission seeks comment on how anchor prices may be established in the future, once incumbent LECs have fully transitioned away from TDM towards packet-based services.  As an interim solution, the Commission proposes to make permanent, after the interim rule expires, the current network transition requirement adopted in the Emerging Wireline Order which requires an ILEC discontinuing TDM service to offer a comparable packet service at comparable prices.   

Possible Carve Out or Exemption from Anchor-based Pricing for Smaller Providers - The Commission also asks whether certain providers should be excluded from this regime, and asks whether providers be subject to rate regulation, or whether some providers should be excluded?  And if so, how best to identify and carve out such providers?  Indeed, the Commission asks whether rate regulation should apply only to the largest providers, and whether such an approach could account for changing market shares over time.  The Commission also asks whether providers with a smaller percentage of market share should not be subject to rate regulation on the ground that smaller providers likely represent new entrants.

Rate Disclosure Requirements - The Commission also proposes to require providers subject to the new anchor-based pricing or benchmark pricing regime to publicly disclose their “generally available” rates, terms, and conditions on the provider’s website.  The proposal is silent on the question of whether such terms must include promotional pricing, limited offers, or those price terms established under individual case basis (or “ICB”) arrangements.

IV.  Prohibited Tariff Practices

As noted above, the item also includes an order finding that certain ILEC tariff practices are prohibited.  In October 2015, the Commission released a Designation Order that initiated an investigation into the terms and conditions of 18 business data services tariff pricing plans offered by large incumbent telecommunications carriers.  This investigation came in response to allegations from competitive carriers that the terms and conditions of the business data service pricing plans constrained their ability to compete in the business data services market and inhibited their transition to IP technologies.  In this Order, subsequent to the investigation, the Commission concluded that “all-or-nothing” provisions included in pricing plans are unjust and unreasonable practices, and that shortfall and early termination penalties contained in pricing plans are unjust and unreasonable to the extent that the penalties exceed expectation damages.

• “All-or-nothing” Provisions - The Commission found “all-or-nothing” provisions in tariff pricing plans to be unjust and unreasonable, expressly prohibited their inclusion in pricing plans, and directed their removal from tariffs prospectively.  These plans require customers to commit all of their relevant in-service purchases to a single pricing plan, which limits the ability of customers to allocate their purchases across different plans.  For example, incumbent carriers may no longer require the customer to pay shortfall penalties if they do not meet a threshold percentage (90%) purchase commitment level.  The FCC’s finding that these provisions are unlawful is a victory for competitive carriers who may now manage their TDM-based business data services in an economically efficient manager while also considering competitive alternatives.
• Shortfall Penalties - The Commission found the shortfall penalties, contained in several of the incumbent pricing plans, are unjust and unreasonable practices pursuant to section 201(b).  Shortfall penalties are charges assessed on a purchaser under a business data services pricing plan if its purchases fall below a percentage-based or other volume commitment specified in the plan as a precondition for obtaining the pricing plan’s discount or circuit portability benefit.  For example, if a customer’s purchases fall below a 90% purchase commitment, as enumerated in the pricing plan, the incumbent carrier may not penalize the customer beyond an amount greater than what the customer would have paid had it met its minimum commitment (expectation damages).
  
  In reaching this conclusion, the FCC determined that a reasonable shortfall penalty allows the seller to recover from the purchaser an amount no greater than the amount the purchaser would have paid had it met its minimum commitment level for service.  The FCC’s conclusion that shortfall penalties beyond the level of expectation damages are indeed unjust and unreasonable will benefit customers of business data services seeking to transition to IP services by minimizing the costs of moving away from their TDM business data service commitments.
• Early Termination Penalties - The Commission found that early termination provisions are unreasonable when they impose upon the customer a fee that exceeds the opportunity cost the incumbent carrier would incur as a result of an early termination.  Early termination fees are charges assessed on a purchases under a business data services pricing plan when the purchaser terminates its use of a circuit or circuits prior to the expiration of the applicable service term.  For example, if a customer terminates the use of its circuits three years into a five year commitment, the early termination fee cannot exceed the opportunity cost the incumbent carrier would incur as a result of an early termination (expectation damages).
  
  As customers of business data services increasingly seek to transition to IP-based technologies, the Commission found that early termination fees pose a harmful barrier to this transition.  The FCC’s finding reflects a favorable outcome for competitive providers who have complained bitterly about the impact of such provisions.

V.  Other Proposed Prohibited Practices

In the FNPRM, the Commission proposes alternatives and seeks comment on a number of allegedly harmful terms and conditions in business data services pricing plans.  Many of these proposals arise from allegations raised by competitive carriers.

• Restrictions on Tying Arrangements - Competitive carriers allege that incumbent carriers use their market position in the TDM services to leverage their sales of Ethernet services, which impairs and impedes competitors from constructing and offering Ethernet business data services.
  
  The FCC proposes prohibiting tariff and other contractual arrangements that condition the sale of business data services in a non-competitive market on the sale of such services in a competitive market.  The Commission believes that this proposal will likely lead to a more competitive business data services market and foster the transition to IP technologies.
• Percentage Commitments - The FCC chose to restrict the penalties associated with a breach of percentage commitments by a purchaser in the Tariff Investigation Order.  In the NPRM, the FCC asks whether provisions requiring customers of business data services to meet certain percentage commitments should be codified and included in the Commission’s rules.
• Term Commitments - Term commitments require customers that participate in a term pricing plan to commit to continue to make those purchases for a set term of months or years.  The Commission asks whether action on term commitments is necessary to ensure that term commitments will not harm competition or impede investment and deployment of competitive IP-based networks.
• Upper Percentage Thresholds - The Commission asks whether to prohibit requirements that force business data services customers to commit to an increased purchase volume or to pay an overage penalty when the customer purchases increase more than a set percentage above their initial volume commitment during the term of their plan.
• Overage Penalties - Overage penalties function as the enforcement mechanism for the upper volume thresholds addressed above.  The Commission seeks comment on the question of whether to prohibit overage penalties as a means to enforce upper percentage thresholds.
• Automatic Renewal & Evergreen Provisions - Competitive carriers allege that incumbent tariff pricing plans include provisions that apply upon expiration of the purchaser’s agreement to buy services and tend to lock purchasers into recommitting to purchase those plans under essentially the same terms and prices of the previous agreements, which impair competition and inhibits technology transitions.
  
  The FCC proposes to “prohibit automatic renewal provisions in tariff pricing plans and contract tariffs for the provision of TDM based broadband data services in non-competitive areas,” which, if implemented, would allow purchasers the ability to modify their commitments or seek alternative providers to supply their needs.

VI.  Prohibition on Tariffing

The FCC recognizes that carriers have many methods to communicate rates to their customers, and asks whether tariffing requirements are necessary for the protection of consumers.  Further, the FCC asks whether implementation of its proposal for broadband data services in competitive markets would require that the FCC no longer enforce tariff requirements, to the extent that a business data services provider is currently subject to those requirements, by forbearing from section 203. 

VII.  Ongoing Data Collection Requirements

In order to monitor the state of competition and measure the effectiveness of the Commission’s regulatory framework, the FCC concludes that it must have detailed service information from service providers.  Therefore, to update analysis of the business data services industry going forward, the FCC proposes to conduct a periodic collection of data every three years, starting with the college of year-end 2017 data. 

The FCC proposes to make this data collection mandatory, and, interestingly, finds that the burden on filers collecting such information is not outweighed by the corresponding benefits of having the information for market analysis.  However, the FCC does propose to limit the scope of the periodic data collection by excluding competitive providers below a set threshold based on either locations with connections, number of business data services customers, or business data services revenues.  The FCC proposes to require incumbent carriers to report locations where they have connections and provide business data services.  Additionally, the FCC proposes to require competitive providers to report locations where they have in-service or idle connections, including all locations where the competitive provider has a fiber connection.  The FCC also proposes to require all providers to submit monthly business data services billing information.  As a reprieve to purchasers of business data services, the FCC proposes to not require purchasers to submit data on a mandatory basis, but instead proposes to conduct a voluntary survey of business data service purchasers beginning in 2017.

VIII.  Conclusion

Initial comments to these far-reaching and potentially invasive and disruptive new rules are due June 28, 2016; with reply comments due July 26, 2016.  For assistance or further questions on these matters please contact us at your convenience.