How Telephone Companies Make Money

1. Regulated Earnings How Telephone Companies Make Money in Telecommunications Doug Kitch Vince Wiemer

2. Discussion • Rate-of-Return Regulation • Revenue Requirement • Jurisdictional Separations • Cost Recovery • Local Rates • Access • The NECA Pools • Universal Service Funds

3. Rate-of-Return • A method of utility regulation that provides a company with an exclusive service area but limits their earnings • The utility earns a pre-determined rate-of-return on their utility investment plus recovers allowed operating expenses and income taxes

4. Rate-of-Return (cont’d) • RoR regulation was put in place to encourage the large investments required for utilities • Common for gas, electric, and telephone utilities • The amount of money that a RoR utility is entitled to earn is called their REVENUE REQUIREMENT

5. Revenue Requirement • The authorized level of earnings allowed Telephone Property, Plant & Equipment - Accumulated Depreciation = Rate Base x Rate-of-Return % = Return on Rate Base + Operating Expenses + Income Taxes = REVENUE REQUIREMENT

6. Revenue Requirement (cont’d) • Rate-of-Return regulation means that more plant investment and more operating expenses result in more income (revenue requirement)

7. Revenue Requirement Example • RoR also means that over time, earnings will decrease as plant depreciates

8. Jurisdictional Separations • Telephone carriers are regulated by both state & federal government • State jurisdiction → local & state toll • Federal jurisdiction → interstate toll • So rate base and revenue requirement must be divided into their respective jurisdictions • Separations or “cost” studies are performed to accomplish this task

9. Separations Net Telephone Plant x Rate of Return + Operating Expenses = Total Revenue Requirement JurisdictionalSeparations Interstate Revenue Requirement State & Local Revenue Requirement

10. Part 36: Separations Rules • Primary purpose of Part 36 is to assign “property costs, revenues, expenses, taxes and reserves between state and interstate jurisdictions” • Costs are categorized based on function and use of the related plant

11. Basic Studies • Four basic studies are performed to determine the use of facilities: • Traffic Study • Commercial Office Study • Central Office Equipment Study • Cable & Wire Facility Study • Then costs (plant balances & expenses) are allocated to jurisdictions based on these usage factors

12. Cost Recovery • Once the jurisdictional revenue requirements are determined, there is the issue of recovering the costs • Telephone companies have three revenue streams: • Local service rates from end-users • Access rates from long distance carriers • Interstate and State access rates • Universal Service Funds from the Federal & state governments

13. Revenue Sources Total Revenue Requirement JurisdictionalSeparations Interstate Revenue Requirement State & Local Revenue Requirement Interstate Access NECA Pools Local Revenue Intrastate Access USF

14. Universal Service & Rates • All rates are influenced by universal service • Universal Service is a policy that states that all Americans have the right to quality telecommunications services at affordable rates • Because of universal service, local telephone service in urban areas subsidizes rural service

15. Cost Recovery (cont’d) • Local Rates are set by State PUC • Access rates are determined by the cost of providing toll services (access costs) • Determined by cost study • Universal service funds make up most of the difference between the cost of providing local service and the local rate

16. Access Rates • Access costs vary for each telco Access cost ÷ Toll minutes = Access rate • For ease of administration, the National Exchange Carrier Association (NECA) produces one tariff for a large number of telcos

17. Access: NECA Pools • The telco charges the long distance company the tariff rate (the average access rate developed by NECA) • NECA pools the money and distributes it to the telco based on the telco’s individual costs • Determined from the cost study

18. Universal Service Funds • Universal service funds are government subsidies for local service in high cost area • The telco’s average cost per loop is calculated [rate base + operating expenses] ÷ number of lines and compared to the National Avg Cost per Loop (NACPL) • A percentage of the difference is received as a subsidy

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