The Jeff Pulver Blog: Guest Blogger: Daniel Berninger - "Universal Service Fund generated remarkably meager results for $50 billion spent"

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July 10, 2006

Guest Blogger: Daniel Berninger - "Universal Service Fund generated remarkably meager results for $50 billion spent"

* An open letter to Congressional Commerce Committees *

July 10, 2006

The Honorable Ted Stevens, Chairman
Senate Committee on Commerce, Science and Transportation

The Honorable Joe Barton, Chairman
House Committee on Energy and Commerce

Dear Chairman Stevens and Chairman Barton:

The importance of achieving universal access to telephone service motivates a request that your committees open hearings to account for how the $50 billion spent by the Universal Service Fund (USF) over the last 20 years contributed to the cause of universal service.

More than five million households remain without regular access to telephone service in the United States. Penetration rates increased 2% from 1985 to 1995 as the USF consumed $7bn in the program's first decade and an additional 1% of households got telephone service between 1996 and 2005 as the USF spent another $43bn (see FCC Trend report). This might seem like progress albeit small and expensive ($16,000 per additional telephone line) until one notices the penetration rate for telephone service grew 2% in the 70's before the USF existed.

Per capita income doubled since the USF was created from $14,000 to $30,000 (see US Bureau of Economic Analysis), so one expects affordabiliy of telephone service to improve. The income improvement probably should have produced an even larger benefit in penetration rates, except the local telephone monopolies increased prices at about the same pace as income improvements. According to the FCC, the average price of a local access line increased 70% from $14 to $24 over the period. The habit of introducing separate charges for services formerly included in the basic rate (e.g. activation and directory assistance) likely makes the increase for equivalent services 100%.

The USF serves to preserves monopoly which is the root cause for our failure to achieve universal service. The FCC's recently announced plans for USF assessments on VoIP companies illustrates the problem. Imagine a policy where IBM manages to extract revenue from the emerging PC industry in order to subsidize access to 1970's era mainframes. The FCC implemented just this policy in extracting revenues from VoIP companies to subsidize local telephone monopolies. Even worse than a tax, the assessment gets made on gross revenues. If some clever VoIP startup manages a 10% pre-tax income margin like present day IBM, the FCC's 7% gross revenue assessment sends 70% of this profit to the incumbent monopolists. A company like Vonage already pays 30% of revenues toward terminating calls on the PSTN. Poof. Now its 37%. This sort of regulatory fiat underlies the reluctance of capital markets to fund the competition necessary to lower prices.

The anti-competitive structure of the USF in assessing low margin (competitive) LD revenues to subsidize high margin (monopoly) local access defies common sense. The price increases for local telephone lines persisted over the years even as the labor and equipment costs declined and as competitive segments of the industry achieved significant price reductions. Average per minute LD rates declined from 35 cents in 1983 to 5 cents recently. The price of cellular calls decreased by a factor of 20 since 1986. Note that VoIP companies will pay into the fund, but they can't apply for support from the fund. The FCC concluded the new assessment obligations would have minimal impact on (monopoly) ILEC's, but the FCC did not even feel the need to address the impact on (competitive) VoIP companies.

The FCC and Universal Service Administration Company (USAC) don't appear concerned about the lack of results, because they don't actually track the impact of the fund in terms of universal service metrics. The USF represents a bureaucrat's dream, because there exists no accountability for results. Success gets judged purely in terms of collecting and spending money. (The USAC's annual report) does not mention penetration rates or any other metric that might qualify as a measure of universal service (i.e. fund results) rather than money (i.e. fund input.) The fact that the telephone industry insiders dominating the USAC board remain silent about the lack of results further shows the program exists to serve telephone companies not the cause of universal service. The FCC's 150 page NPRM that accompanied the order assessing VoIP companies does not include a single mention of how or whether the funds contributed to the USF actually further the cause of universal service.

Tracking the number of households participating in the USF's Low Income Program is as close as the FCC comes to tracking results. The monies collected and distributed by the Low Income Program doubled from $400mn to $800mn since 1997, but the nature of local telephone monopoly keeps people disconnected. The program provides on average $8 per month subsidy for qualifying low income telephone customers, but the subsidy does not solve the affordability problem given an average telephone bill of $50 per month. Even aside from basic rates that increase year after year, setup charges, strict credit terms, and demand for deposits keep as many as 20% of households in low income areas without telephone service. Competition from VoIP companies recently led Verizon to advertise a price reduction of $17 per month (i.e. twice the USF Low Income subsidy) on its unlimited usage plan. VoIP companies serve less than 3% of access lines, so this represents only the beginning of the industry's competitive potential. Yet, the new USF assessment helps defeat VoIP competition.

The lack of results deserves attention, but the lack of results coupled with rapid growth of the fund represents a crisis. The FCC's plan to assess VoIP does not come near to solving the funding challenges. The USF grew from $1.5bn in the year before the changes implemented by the Telecom Act of 1996 to $6.5bn in 2005. The fund continues to grow 12% annually in recent years, so at this pace it will double again in the next six years. LD revenues have declined 50% from a peak in 1999, so the FCC mandated revenue assessment grew twice as fast as the fund (from 1.2% in 1997 to 10.7% in 2005.) It does not help matters the Bells find ways to minimize USF contributions even as they increase their share of LD revenues. In 2005, the Bell LD division USF contributions amounted to about 1/3 of those by the former LD pure plays (i.e. AT&T, MCI, and Sprint) even given about equal market share positions. Note that FCC removed USF obligations on Bell company DSL revenues at the same time it asserted them on VoIP companies.

The Schools and Libraries Program can point to some results in getting schools and libraries wired for Internet, but the inability of the FCC to cope with fraud by applicants to the fund leaves the program in a shambles. In any case, more than half of the $1 billion in funding commitments during 2005 cover the provision traditional telephone service. The disconnect between funding commitments and disbursements exceeds 12 months in many cases, and no competitive provider of telecommunication services can wait a year to get paid. The school districts do not ultimately pay the bill, so they do not complain about the fact telephone companies extract a 50% premium above the usual $50 ARPU for bills paid through the USF. Schools end up with expensive centrex services where they pay per minute for local calls, 15% of the bill arises moves and adds, and 10% of monthly costs arise from directory assistance.

The High Cost Fund (HCF) grew from $56mn in 1986 to $3.6bn in 2005. There exists no doubt the cost of connecting customers in low density areas of the country exceeds the costs in high density areas, but the USF's record of collecting and spending money has worked against bringing communications to rural areas. Keep in mind the issue of high cost revolves around the one time fixed cost of deploying outside plant to reach remote areas. The variable costs of delivering service in rural areas after the copper or fiber gets deployed does not differ substantially from any other location. The FCC's data shows the number of access lines in the 25 states that get more from the HCF than they contribute grew from 50mn to 55mn between 1997 and 2003. Its not clear the HCF deserves credit for any of 10% increase, because applications for HCF payments require claims of expenses not the actual deployment of access lines. The vast majority of the money goes to subsidizing access lines deployed before the fund existed. The expectation of these monies actually preserves operating inefficiencies, because reducing costs means lower HCF payments.

There will exist positive stories arising from the USF's consumption of $50bn, but the program does far more harm than good. The fact it serves the interest of telephone monopolies not universal service is illustrated by how very little communication the $50bn purchased. There needs to be some measure of accountability for the fund to further the cause of universal service.

Anyone that cares about the cause of universal service cannot support the continuation of the USF as currently organized.

Sincerly,

Daniel Berninger, Senior Analyst, Tier1 Research

Daniel Berninger, VP and Senior Analyst, Tier1 Research

Daniel Berninger joined Tier1 Research in August 2004 as Senior Analyst covering telecom. Daniel has over a decade of experience that includes helping to launch three prominent VoIP startups - ITXC, Vonage, and Free World Dialup. His expertise on the intersection of telecom and the Internet has been sought by Congress, FCC, Federal Reserve, and state PSCs. Daniel led early VoIP deployments at Verizon, HP, and NASA for VocalTec Communications. He won the 1999 VON Pioneer Award for co-founding the VON Coalition and worked on the original assessment of VoIP at Bell Laboratories. He completed doctoral studies in preparation for a Ph.D. in System Engineering at the University of Pennsylvania.

Tags: USF, Daniel Berninger, VoIP, FCC

(c) 2006 Jeff Pulver. All Rights Reserved.
(This blog posting is copyright protected by Jeff Pulver. Portions of this blog posting may be quoted or abstracted if attributed.)

Posted by jeff on July 10, 2006 05:21 AM | Permalink

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Let's forget about WWII and the performance of yesteryear, let's talk about the last 10 years and where we are today. Since the "Inventor of the Internet" and his cronies in DC have had their hands in this mess look at the numbers "an additional 1% of households got telephone service between 1996 and 2005 as the USF spent another $43bn (see FCC Trend report)". We at NuTel Broadband could use 1% of that and get the same results.

The bureaucracy has to stop some where and adding more taxes on a competitive market is not the way to fix things. Open up the market by limiting most of the restrictions (plus most of the taxes)and let competition set the standard.

Posted by: Roy McMillan at July 16, 2007 05:24 PM

It seems that people reading this post still aren't getting it (See Dave's comment below). The point Berenger is making here is that the USF subsidies are over funding existing infrastructure. It costs far more for initial construction than operation. In most cases, the rural LEC can recover a portion or all of the operational expenses through billing their customers.

"The expectation of these monies actually preserves operating inefficiencies, because reducing costs means lower HCF payments." That quote sums it for me.

Dave, if you need to see a good example of where the USF is being soaked for existing facilities versus new deployment see: http://www.usatoday.com/printedition/money/20041116/ruralphone16.art.htm

Dave's statement below "Universal service requires not only that facilities be constructed, but that the full operating costs of the facilities, including depreciation and return on investment be recovered." while accurate doesn't address the problem. USF dollars are not reaching the intended target of new technology and deployment.

The monopoly structure of our telecommunications system will always work against innovation and lower pricing. Combine that with the powerful telco lobby and you have the formula for continued
mediocre, over priced, limited services.

This article has some interesting figures regarding the telco lobby: http://speakingip.com/wp/2006/07/14/voip-death-taxes/#more-14

Posted by: Sean at July 14, 2006 01:51 PM

"The expectation of these monies actually preserves operating inefficiencies, because reducing costs means lower HCF payments." That quote sums it for me.

Dave, if you need to see a good example of where the USF is being soaked for existing facilities versus new deployment see: http://www.usatoday.com/printedition/money/20041116/ruralphone16.art.htm

This article has some interesting figures regarding the telco lobby: http://speakingip.com/wp/2006/07/14/voip-death-taxes/#more-14

Posted by: Sean at July 14, 2006 01:42 PM

It is certainly true that much could be done to better focus USF support, but Berninger ignores some relevant history. After WWII rural telephone penetration was substantially less than it had been in 1920. The large carriers would not extend their service into low density area. Full universal service was achieved through the combination of REA (now RUS) provision of capital financing to locally owned and controlled telcos and the adoption of the "Ozark" separations manual--the precursor of USF-. Ozark, like the USF, increased the interstate allocation of costs above what a relative use formula would provide. Berninger states incorrectly that USF is directed towards the "one time fixed cost of deploying outside plant." Universal service requires not only that facilities be constructed, but that the full operating costs of the facilities, including depreciation and return on investment be recovered. VOIP services providers could not sell their service unless someone (else) builds, maintains and operates the broadband facility. Although cable systems exist in rural towns, cable service is not generally available outside of towns where rural telephone companies are the only providers of broadband services.

Posted by: Dave at July 12, 2006 02:03 PM

Inciteful, well written letter. In other words, exactly the opposite of the comment from 'chris'. "The city of cincinnati gets it's name from the fact that it is home to cincinnati bell"? Is that a joke? I don't know which was more ridiculous, the absolutely inane assertion that there was Cincinnati Bell before there was the city of Cincinnati or the implications behind the question "what will you do if the phone companies go out of business?".

Posted by: Danny at July 11, 2006 02:15 PM

i don't think that you guys realize how hard it is for ILECs to eke out an existence. it takes more and more time and effort to squeeze millions in profit without investing in new infrastructure.

the local ILEC for cincinnati (cincinnati bell) is losing a hundred access lines a day to cell and cable providers. don't you feel sorry for them? the city of cincinnati gets it's name from the fact that it is home to cincinnati bell.

what will you do if the phone companies go out of business?

Posted by: chris at July 11, 2006 12:32 PM

July 10, 2006

Guest Blogger: Daniel Berninger - "Universal Service Fund generated remarkably meager results for $50 billion spent"

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