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Professional Background
1.  My name is Marius Schwartz. I am a Professor of Economics at Georgetown University.
I received my B.Sc. degree with first-class honors from the London School of Economics and my
Ph.D. in economics from the University of California at Los Angeles. My research areas are in
industrial organization, antitrust and regulation. I have published on these subjects and have taught
courses at Georgetown University and to executives and government officials in the U.S. and other
countries.
2.  From April 1995 to June 1996, I served as the senior staff economist at the President's
Council of Economic Advisers responsible for antitrust and regulated industries. Much of my work
was on regulatory reform in telecommunications, and I participated in the development of the
Administration's policy leading up to the enactment of the 1996 Telecommunications Act. From
1980 to the present, I have served intermittently as a consultant to the Antitrust Division of the
Department of Justice on a wide variety of competition matters. I have also consulted for the OECD,
World Bank, USAID, and private clients. My curriculum vitae is attached to this affidavit.

Scope of Assignment
3.  I have been asked by the Antitrust Division of the U.S. Department of Justice to analyze the
economic conditions under which authorizing regional Bell Operating Company (BOC) provision
of in-region interLATA telecommunications services ("BOC entry") would be consistent with the
public interest in competition, under the entry standard of § 271 of the Telecommunications Act of
1996 ("Act"). I have also been asked for my opinion, in light of my analysis, regarding the Justice
Department's general standard for evaluating BOC applications under § 271 that is described in the
Department's comments filed with the Federal Communications Commission. As part of my
analysis I have considered both the potential costs and benefits of authorizing interLATA entry by
the BOCs, consistently with the specific provisions and overall competitive objectives of Act. I have
not been asked to consider whether any individual BOC has met the requirements of § 271 in a
particular state.
4.  In connection with this assignment, I have drawn on the relevant economics literature and

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consulted with other academics, regulators, practitioners, and industry participants. I have also
reviewed numerous documents, including but not limited to: submissions in connection with the
Motion to Vacate the MFJ that was filed by four BOCs in 1995; submissions in the FCC's
proceedings to implement the 1996 Act's provisions on local competition, accounting and non-
accounting safeguards, and reform of universal service and access charges; the FCC's relevant
Orders; regulatory filings with state commissions; documents submitted to the Department of Justice
pursuant to the pending mergers between Bell Atlantic and NYNEX, and SBC and Pacific Telesis;
and numerous responses submitted to the letter request of Acting Assistant Attorney General Joel
Klein issued on November 21, 1996, concerning the competitive impact of interLATA entry by the
BOCs ("responses to Joel Klein letter").
5.  My assessment is that the Department of Justice's entry standard strikes a good balance
between properly addressing the competitive concerns raised by BOC entry, and realizing the
benefits from such entry as rapidly as can be justified in light of these concerns. The Department's
standard, therefore, is consistent with the public interest in competition reflected in the entry test of
section 271 of the Telecommunications Act.

Summary of Analysis and Conclusions
6.  The 1996 Act aims to increase competition in all telecommunications markets; for the first
time, this includes local markets that today are largely regulated monopolies. It is therefore
necessary to evaluate the effects of BOC entry not only on competition in long-distance services, but
also in local services and in "integrated services" (the offering of both local and long-distance
services—whether bundled or separately—by the same provider).
7.  Under appropriate conditions, BOC entry holds the promise of yielding significant benefits
to the BOCs and to consumers. The principal benefits may include: (a) reductions in retailing costs
enabled by joint provision of local and long-distance services; (b) offering consumers valuable new
options from dealing with providers of integrated services, e.g., the convenience of one-stop
shopping for all their telecommunications requirements; and (c) increasing the degree of competition
in long-distance services (both in interLATA services through BOC entry; and in intraLATA toll

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services in multi-LATA states that now lack dialing parity for entrants, since the Act requires
intraLATA dialing parity in such a state when and only when BOC interLATA entry occurs in the
state).
8.  BOC entry, however, also raises potential concerns. The principal risk of authorizing
premature BOC entry is that doing so will result in significantly less BOC cooperation, than could
be induced by an appropriate entry standard, in providing good access at cost-based prices to the
various functions and services of a BOC's local networks needed by entrants wishing to offer local
or integrated services. These requisite "wholesale local services" include interconnection, unbundled
network elements, and discounted local service for resale. Securing efficient access to these services
of the BOCs' ubiquitous local networks will be critical for some time to the development of
competition in local and integrated services. A BOC's monopolistic withholding of such access
cooperation would be a potent and destructive form of rivalry: it would raise competitors' costs,
degrade their quality, and deny consumers the benefits of new products. And if facilities-based local
competition fails to develop, BOC entry could pose a growing threat to long-distance competition,
since today's established access arrangements will increasingly require changes over time.
9.  Authorizing premature BOC entry would prematurely reduce a BOC's cooperation incentives
for two main reasons: (a) the BOC stands to gain if it can leverage its local market power into the
newly opened markets for long-distance and integrated services; and (b) the BOC is emboldened to
stiffen its resistance to local competition having secured its coveted long-distance authority. After
explaining these incentives, I argue that regulatory and other post-entry safeguards are considerably
less likely to secure the new BOC arrangements for local competition than would a more
procompetitive entry standard.
10.  First, consider leverage incentives. Once the BOC offers long-distance retail services and
thus integrated retail services, it becomes a competitor to its access customers—carriers that must
purchase from it access services used to provide these retail services. A BOC then becomes less
willing to provide access services to others than if it did not offer the retail services itself. This
reduced willingness arises in large part, though by no means entirely, because a BOC's prices for
wholesale local services and for local retail services are likely to remain more tightly regulated than

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its prices for long-distance retail services. Asymmetric regulation of this sort pushes a firm to evade
regulation by leveraging the more tightly regulated market power into the less regulated services that
require access to the regulated bottleneck services. To raise prices of unregulated services, a BOC
must undermine competitors; this it might do—if unchecked by regulation—through various forms
of "access discrimination" that raise competitors' costs or degrade their quality.
11.  Leverage into long-distance services would entail a BOC's degrading of competitors' long-
distance access arrangements; a BOC's ability to do so, however, is limited in the short run (see ¶
14). But leverage into integrated services could entail degrading of competitors' long-distance
access or denying to competitors good access to its wholesale local services—because competitors
need both to offer integrated services. Undermining integrated-service competitors by restricting
their access to wholesale local services could enable a BOC to charge higher prices for its
unregulated long-distance services for two reasons: (1) competitors are denied cost savings from
joint provision of services, which could raise their cost of providing long-distance services and thus
weaken the discipline they impose on the BOC's prices; and (2) some consumers would be willing
to pay a premium for dealing with a provider of integrated services, reflecting, for example, the value
of one-stop-shopping.
12.  Second, and independent of such incentives to leverage market power into long-distance or
integrated services, a BOC like any dominant incumbent is inclined to resist cooperating with local
entrants that threaten its core local market power. This resistance can be softened—though not
eliminated—by authorizing a BOC's long-distance entry only if its adequate cooperation with local
entrants has first been secured. Before entry is authorized, the lure of added profit from long-
distance and integrated services gives the BOC an incentive to expedite its required cooperation;
after entry, however, time is on the BOC's side and its inclination to cooperate correspondingly
diminishes. As a practical matter, rescinding a BOC's entry authority if it slows down its
cooperation may well be difficult as well as disruptive. (Halting its future marketing efforts may be
a more practical option, but is also less potent.)
13.  For these reasons, once a BOC's entry is authorized, its incentives to cooperate in providing
network access to competitors will diminish significantly. Therefore, a key question is: how

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effectively can regulatory and other safeguards enforce the requisite BOC cooperation post entry in
the face of reduced BOC incentives? Economic reasoning suggests—and historical experience
confirms—that the efficacy of regulatory and other "outside enforcement" varies widely with the
economic environment. Regulation fares much better in a stable environment where regulators
understand what is and is not standard practice, than in a rapidly changing environment where more
frequent adjustments are needed and informational asymmetries are greater. Correspondingly,
regulatory oversight can do a reasonable job of maintaining well-established arrangements; but it is
far less adept at forcing incumbents to rapidly implement new arrangements, as the lack of historical
benchmarks on acceptable performance gives incumbents great latitude to engage in plausible
deniability. These observations have important implications.
14.  Access arrangements for long-distance services are largely well established; hence regulatory
and other safeguards can prevent significant degradation. Although the necessary access
arrangements will certainly evolve over time, I understand that radical changes in technical
arrangements governing the majority of interexchange revenues are not imminent. While customized
arrangements pose a potential problem, such arrangements are used mainly by large customers for
whom competitive access alternatives have developed more rapidly. On balance, therefore,
regulatory and other safeguards can render the threat to technical arrangements for long-distance
access tolerable, at least in the short run.
15.  The picture is quite different for access arrangements to wholesale local services. These
requisite arrangements are largely new; their implementation will require extensive cooperation by
incumbents in developing a host of technical, operational and business protocols, and in establishing
appropriate prices.
16.  Mandating incumbents' cooperation, as the Act does, surely helps; but the process will
evolve much more quickly and efficiently if incumbents have better incentives to cooperate. Thus,
the Act sets up the § 271 process which, as is widely acknowledged, only allows for BOC entry when
such local-competition access arrangements are meaningfully made available and the market is truly
open to competition. This sequencing serves important purposes, as described below. Regulators
and other outside enforcers have significantly inferior information than a BOC about how to

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implement these new systems and how long the task should take. These informational asymmetries
hinder reliance on post-entry measures (such as halting BOC marketing of long-distance services,
or imposing financial penalties) to force BOC implementation of these new arrangements, since
enforcers' uncertainty about how long implementation should take makes it difficult (and inefficient)
to specify rigid deadlines.
17.  As the § 271 sequencing recognizes, however, these difficulties can be significantly mitigated
by requiring as pre-conditions for BOC entry that all major new systems necessary to open the local
market have been made available to entrants, and that their performance has been sufficiently
demonstrated; absent such a demonstration, one cannot be confident that the systems indeed do what
they promise. Such an entry standard does a better job of aligning incentives: the more informed
BOC then has stronger incentives to implement things rapidly in order to expedite opening the local
market and thereby its own long-distance entry. And establishing performance benchmarks to gauge
the functioning of these new arrangements before authorizing BOC entry renders post-entry
safeguards—regulatory, antitrust and contractual—more effective at countering subsequent BOC
incentives to degrade these arrangements. Thus, authorizing BOC entry only after a BOC institutes
the new access arrangements that are necessary to open the local market to competition is likely to
greatly accelerate the emergence of local competition.
18.  Although delaying BOC entry until the local market is open may impose some costs, the
more rapid opening of the local market that will result is likely to yield significantly larger benefits
to consumers. The local market is more than twice as large as long distance (net of access charges),
and is largely a regulated monopoly; thus, adding even a modest dose of competition could yield
major gains in lower costs and prices, improved service, and product innovation. BOC cooperation
in providing wholesale local services also could permit others to compete relatively quickly in
integrated services (such as by reselling local services along with long-distance and other services);
the ability to offer integrated services is important to enabling long-distance carriers and others to
compete effectively with a BOC once it is authorized to offer long-distance service. And in the long
run, facilities-based local competition can aid regulation—and eventually, one would hope, supplant
it—in safeguarding access arrangements for long-distance services in a less intrusive manner.

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19.  The foregoing analysis persuades me that BOC entry is appropriate when, and only when,
the market in the state has been irreversibly opened to local competition. I believe this entry standard
will provide incentives to the BOCs to extend the cooperation necessary to open local markets more
rapidly and efficiently; will help establish the benchmarks enforcers need to maintain the new access
arrangements post entry; and will permit BOC entry as rapidly as is consistent with these constraints.
Opening the market does not require evidence of local competition of all forms and in all regions of a state sufficient to substantially discipline BOC market power. The Act aims to let market forces
determine what forms of entry work best and where; and regulatory and other safeguards will still
play a role in disciplining BOC abuse of market power. But, at a minimum, opening the local market
requires full, meaningful implementation of the § 271 competitive checklist, not mere paper
compliance.
20.  By far the best test of whether the local market has been opened to competition is whether
meaningful local competition emerges. Local competition establishes presumptions; the more
widespread and varied it is, the greater our confidence that the market has been opened. In
particular, use on a commercial scale of the new access arrangements needed to support all three
modes of local entry envisioned in the Act—facilities-based, unbundled elements, and
resale—demonstrates that competitors are obtaining what they need from the BOC. Local
competition, even on a modest scale, can also signal entrants' willingness to commit investments
and demonstrate their confidence in the openness of the market. Finally, the presence of local
competitors can directly assist regulators in preventing future backsliding by the dominant
incumbents.
21.  If sufficiently diverse competition fails to develop, it is important to understand why. As
implied earlier, one possibility is simply lack of interest by entrants in pursuing certain entry modes
in certain regions. But before reaching such a conclusion, it is important to ascertain that
competition is not being stifled by artificial barriers. Thus, if sufficient competition fails to develop,
there should be a rebuttable presumption that this is not due to lack of entrants' interest, but to a
failure to irreversibly open the local market. Rebutting this presumption requires ascertaining that
the main elements of an open market indeed are in place. The most important element, the logic for

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which was explained earlier, is the following. New technical and operational arrangements must
be available and shown to be working: to support all three entry modes envisioned in the Act; on a
sufficient scale, and capable of being rapidly expanded and extended to regions where they are not
initially implemented; and for sufficient duration and variety to provide reliable benchmarks to
assess and enforce future cooperation.
22.   Procompetitive pricing of these key inputs also is necessary to inspire confidence that,
despite the absence of sufficient actual competition, the market is indeed open. Prohibitively high
prices would render the new access arrangements meaningless; to permit efficient local entry,
entrants must have adequate assurance that BOC prices for these inputs will remain reasonable and
cost-based after interLATA relief is granted. (The FCC has determined that the appropriate costs
are: forward-looking incremental cost for unbundled network elements and for transport and
termination of local calls; and wholesale discounts off the retail price that are close to the
incumbent's avoided retailing costs, in the case of local service sold to other carriers for resale.)
Awareness that the § 271 entry process will weigh seriously whether key inputs are priced in a
manner that supports efficient competitive entry will usefully complement state efforts in opening
local markets.
23.  Finally, one must ascertain that competition is not being hindered by any lingering major
state regulatory or other artificial barriers. (Although such barriers may be subject to preemption
under § 253 of the Act, the timeliness and effectiveness of any such FCC preemption decisions is
uncertain.) If such barriers are likely for some time to seriously hinder competitors' ability to avail
themselves of the new access arrangements put in place with BOC cooperation, these arrangements
could become obsolete and the value of such BOC cooperation will decay; and securing this
cooperation again once the barriers have been removed but after BOC entry has been authorized will
be considerably harder.
24.  In short, if sufficient local competition is observed, this demonstrates that the market has
been irreversibly opened; if not, one should exercise more caution in approving the BOC's entry,
and insist on offsetting evidence that the market indeed has been irreversibly opened. I have
reviewed the Department of Justice's entry standard in light of this analysis. I conclude that it strikes

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a good balance between properly addressing the competitive concerns raised by BOC entry, and
realizing the benefits from such entry as rapidly as can be justified in light of these concerns. It
therefore serves the public interest in fostering competition.

I.  The 1996 Telecommunications Act and BOC Entry into Long-Distance Services
25.  The 1996 Act represents a major shift in U.S. telecommunications policy by establishing as
a federal goal the promotion of competition in all telecommunications services. The most significant
change is the requirement that local telephone markets, heretofore regulated franchise monopolies,
be opened to competition. In addition and relatedly, the Act establishes a procedure for authorizing
the BOCs to offer long-distance (interLATA) telecommunications services originating in their
service regions after a BOC has sufficiently opened its local markets to competition and BOC entry
is judged to be in the public interest.
26.  Section A below reviews the main relevant telecommunications markets and Section B
discusses the Act's goals of increasing competition and improving performance in these markets.
Section C stresses why BOC cooperation will be critical to achieving the Act's goals, and section
D discusses the benefits and costs of authorizing BOC entry before there is effective local
competition. Based on this analysis, section E discusses the main principles that a procompetitive
entry standard should incorporate.
   A. The Major Telecommunications Markets Relevant to BOC Entry
27.  The 1982 consent decree that broke up the vertically integrated Bell system (Modification
of Final Judgment, "MFJ" ¹ ) created seven new regional BOCs, and divided those parts of the country
served by the Bell system into Local Access and Transport Areas (LATAs); today, the BOCs serve
164 LATAs. Under the MFJ, a BOC could only offer telecommunications services within LATAs
(intraLATA). InterLATA services have been provided by long-distance companies, also known as
interexchange carriers (IXCs). Recently, however, some local exchange carriers (LECs) not subject

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to the Act's § 271 interLATA restriction on the BOCs, have been making serious inroads into long-
distance services.
28.  Superseding the MFJ, the 1996 Act authorizes any BOC immediately to offer long-distance
(interLATA) services that originate in states outside its service regions. But to offer interLATA
services originating in its region, a BOC must receive FCC approval under § 271 of the Act. A BOC
applies for approval state-wide. ² Approval is granted only after the FCC determines all of the
following: (a) which if any of the two tracks stipulated in the Act the BOC is eligible to use at the
time to satisfy the competitive checklist requiring it to open its local markets in the state to
competition: Track A (interconnection agreement with a facilities-based competitor serving business
and residential customers), or Track B (statement of generally offered terms to competitors where
no request has been made by a provider for access and interconnection); (b) after consulting with the
state commission, determines that the BOC, through Track A or B, has satisfied the competitive
checklist; and (c) determines that such approval is in the public interest. In making its determination
on a § 271 application, the FCC must consult with the Department of Justice and give substantial
weight to its competitive assessment. (In addition, § 272 requires the BOC to offer interLATA
services, both in and out of region, through a separate affiliate subject to certain safeguards.)
29.  Since the Act links a BOC's interLATA entry authority to the opening of its local markets,
in advocating a particular entry standard one must consider its effects on competition in both
interLATA and local markets.
         1.  The BOCs dominate key local networks and are regulated
30.  Table 1 shows telecommunications revenues from local (intraLATA) markets now dominated
by the BOCs in their regions, and from long-distance (interLATA) markets which the BOCs seek
to enter. The data are for 1995, the most recent year for which comprehensive data are available. ³

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Despite some changes since the passage of the Act, notably an increase in the activity of local
entrants (discussed shortly), the basic market relationships shown by the 1995 data have not changed
markedly. Two points stand out. First, local revenues are twice as large as long-distance revenues
(net of access payments collected by LECs). Second, incumbent LECs account for the vast majority
of local revenues: $102.8 bn compared with a combined $0.6 bn for CAPs and CLECs; although
CAP plus CLEC revenue has risen to about $2 billion in 1996, it is still dwarfed by LEC revenues.

31.  In their service regions the BOCs have virtual monopolies over switched services, both local
exchange and exchange access to long-distance carriers. They also dominate special (or dedicated)
access used by long-distance carriers. And in most states they also dominate intraLATA toll
services, due to the BOCs' continuing ability in those states to deny to IXCs dialing parity (the
ability of a customer to make intraLATA toll calls through an IXC without dialing more digits than
through the BOC) before the BOCs begin providing interLATA services in these states. ⁴ In 1995,
the ratio of LEC revenues nationwide to long-distance revenue net of access was about 2-to-1 (Table
1); the BOCs accounted for about 73% of all LEC revenues nationwide (Table 1) and about 77% of
all interLATA minutes originated in BOC service areas (SCCC, Table 2.10). The 2-to-1 ratio
therefore is also a reasonable approximation of the relative sizes of (a) those markets which a BOC
now dominates (local markets in its service areas) versus (b) those markets now closed to a BOC and
in which the BOC would have the greatest impact (interLATA calls originating in its service areas). ⁵

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32.  In recent years, certain local competition has emerged. In central business districts, CAPs
have constructed networks that enable large customers to bypass LECs and link directly to IXCs
(mainly to send but not receive calls), and provide some links between local private networks. One
can expect CAPs and CLECs to expand into switched services, since the 1996 Act preempts many
legal barriers that had precluded competition for such switched services in many states. ⁶ But CAPs
and other local entrants face more than just legal hurdles.
33.  Expanding local operations is expensive, and requires significant cooperation from
incumbents. As mentioned, the BOCs in their regions retain the only ubiquitous switched local
networks. These consist of several major elements. (a) The local loop is the sets of wires linking
subscriber premises to the telephone company's wire centers (or "central offices"). This local
distribution plant is by far the most expensive network element; duplicating it on a large scale would
be prohibitively costly, and probably inefficient. (b) Switching facilities allow subscribers to
communicate indirectly (as opposed to using point-to-point links) with others. Virtually all
residential subscribers and small businesses depend on switched local access to originate and to
terminate both their local and long distance calls, as non-switched access is only economical for
large users. (c) Local transport facilities are high capacity trunk lines that connect central offices
or other switches. (d) The BOCs also control key databases, and key network signaling
functions—the flow of information associated with setting up, disconnecting, and otherwise
controlling a telephone call (information such as the identity of the parties, the duration of the call

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and the signal being transmitted, e.g., voice or data).
34.  In view of their substantial market power, the BOCs and other LECs remain regulated in their
prices for most local services and exchange access. Moreover, as explained shortly, the new Act
requires incumbent LECs to offer numerous new "wholesale" local services at regulated prices to
other telecommunications providers.
         2.  Long-distance markets are relatively competitive and largely unregulated
35.  The extent of competitiveness of long-distance markets is hotly debated (see section II.C);
but it is surely greater than in local services. There are four national IXCs, which in 1995 had the
following revenue shares: AT&T 53%, MCI 18%, Sprint 10%, LDDS/WorldCom 5%; there are also
numerous other carriers, with a significant total market share of 14% (SCCC, 1995/96, Table 1.4).
And there is considerable switching of customers between carriers. In short, while there is not
perfect competition, there is considerable competition. ⁷
         3.  Inefficiencies in the present industry structure
36.  While the MFJ succeeded in increasing competition in long-distance services, the current
structure of the U.S. telecommunications industry is surely far from perfect.
37.   Losses from separation. The MFJ's separation of activities based on LATAs imposes certain
costs. As explained in section II, it precludes the BOCs from attempting to exploit various
economies of scope, especially on the retailing side, associated with joint provision of local and
long-distance services; from offering consumers the benefits of one-stop shopping and new services
that require both local and interLATA facilities; and from bringing more competition to long-
distance services (see the ensuing section I.D.1). LATA boundaries necessarily impose artificial

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separation between points near the boundaries, and do not always conform to economic markets or
efficient network configurations. LATAs vary widely in size and population; intraLATA calls can
travel hundreds of miles, thereby better resembling long-distance calls than local calls as regards the
network facilities utilized. ⁸ For all these reasons, confining the BOCs (or any other firms) to
particular geographic regions or types of services is not a first-best solution.
38.   Absence of local competition. But the most glaring problem today is one that the MFJ was
not designed to alter: the absence of local competition. Indeed, confining the BOCs may have been
the best guardian of nascent long-distance competition in an era where persistence of the BOCs'
regulated local monopolies was taken as given. Replacing such monopolies with local competition,
however, can ultimately provide a better safeguard for long-distance competition, ⁹ while also
allowing removal of current restrictions on the BOCs.
39.  In addition to safeguarding competition in long distance, introducing local competition at this
point is likely to yield even greater benefits by improving market performance in the provision of
local services, including local exchange and exchange access, and of integrated services. The local
market is more than twice as large as long distance (Table 1), and is largely monopolized by
incumbent LECs. While regulation holds down some LEC prices, it introduces its own costs. ¹⁰
These include: a distorted price structure; rigidities in adjusting prices to changing conditions; and

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weakening firms' incentives to contain costs (if regulation is largely cost-based), to maintain quality
(if regulation is of the price-cap variety), and to be innovative and responsive to customer demands.
Where feasible, competition is far superior to regulated monopoly as a device for promoting cost
reduction, innovation, and superior service.
   B.  The New Competitive Vision in the 1996 Act
40.  The 1996 Act creates a clean slate and offers an unusual opportunity to remedy many of the
above deficiencies in the present industry structure.
         1.  The Act aims to promote unfettered competition in all markets
41.  The Act's unifying goal is increased competition in all markets and the eventual elimination
of artificial service boundaries. This means more competition in providing: local services; long-
distance services; and "integrated services"—the options of one-stop shopping for, or obtaining
bundled packages of, these and other telecommunications services. ¹¹
42.  If successful in promoting local competition, the Act will eventually allow the replacement
of detailed, hands-on regulation of local retail prices and services with a combination of local
competition and more confined and less intrusive regulation of only key bottleneck network
services. ¹² (Some regulation of interconnection, especially of termination charges, will be necessary
for some time, as explained shortly.) And it will permit any firm to offer any service anywhere,
including doing away with restrictions on what services the BOCs may offer and how. As the FCC
put it:
   Indeed, the relationship between fostering competition in local telecommunications markets
   and promoting greater competition in the long distance market is fundamental to the 1996
   Act. . . the opening of one of the last monopoly bottleneck strongholds in
   telecommunications -- the local exchange and exchange access markets -- to competition is

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   intended to pave the way for enhanced competition in all telecommunications markets, by
   allowing all providers to enter all markets. ¹³

   2.  The Act seeks to enable various forms of local competition
43.  The Act discusses three forms of entry into local markets: facilities-based, resale, and
unbundled network elements.
44.   Facilities-based entrants serve their subscribers using their own network facilities except to
exchange traffic with the incumbent LEC.
45.   Resellers bring no independent network facilities, but resell under their own name the
existing services provided by the incumbent (total service resale), combined perhaps with other
services. They undertake all the relevant customer-interface functions such as billing and marketing
("retailers" is therefore a better description than the conventionally-used "resellers," since the latter
suggests only an arbitrage function).
46.   Entrants using unbundled elements may lease from the incumbent unbundled network
elements, individually or in combination, for example, leasing the incumbent's unbundled loops but
providing their own switching facilities. ¹⁴
47.  All the above entry modes can serve valuable competitive roles. Facilities-based entry
potentially exerts the greatest competitive discipline on the incumbent. But it may not always be
desirable, as it could require costly duplication of existing facilities such as loops that could more
economically be obtained from the incumbent. Even where desirable, such entry could take
considerable time. It is thus important to recognize the potential value of the other two entry modes.
48.  Entry by firms that are not entirely facilities based can be beneficial in various ways. First,
an entrant could bring direct competitive discipline to those segments it enters, in the form of lower
costs and prices or higher quality. For example, resellers might perform retailing functions more

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effectively than an incumbent; loop unbundlers might limit an incumbent's ability to discriminate
against IXCs through control over the intelligence embedded in the switch. Even entrants that are
no more efficient could undercut the incumbent by accepting a lower profit margin—because
regulation is unlikely to succeed in lowering the incumbent's prices all the way to cost. In addition
to such direct competitive discipline, entrants can provide indirect discipline: by giving regulators
a benchmark of true costs or technical capabilities, they can assist them in better regulating the
incumbent.
49.  Second, such entry can increase product variety and quality. For example, reselling local
services enables entrants that provide also other services to offer one-stop shopping without having
to build facilities for all their services or in all regions; the major IXCs among others view such
ability as very important. Resellers or entrants using unbundled elements might offer new pricing
plans better tailored to certain customers than are the incumbent's offerings. Entrants using
unbundled loops might offer new switch-based ("vertical") services. More generally, smaller
entrepreneurial firms could stimulate innovation if given the opportunity to specialize in segments
where they enjoy a comparative advantage while obtaining from the incumbent at cost-based prices
other unbundled elements they require.
50.  Third, such entry modes can assist and accelerate the transition to full-facilities competition,
by allowing entrants to attain a customer base before being forced to build extensive facilities.
Requiring entrants to be entirely facilities-based at the outset would saddle them with unnecessarily
high fixed costs and excess capacity (while subscribers are being added), making entry more risky
and more costly. Conversely, granting entrants access at reasonable prices to complementary LEC
facilities during the transition could permit a faster and more economical transition to full-facilities
competition. Indeed, in the long-distance market some entrants began mainly as resellers and added
their own capacity as their name recognition and subscriber base grew. ¹⁵

Page 18 .       

51.  Recognizing the potential value of all entry modes, the FCC observes: "Section 251 neither
explicitly nor implicitly expresses a preference for one particular entry strategy. Moreover, given
the likelihood that entrants will combine or alter entry strategies over time, an attempt to indicate
such a preference in our section 251 rules may have unintended and undesirable results. Rather, our
obligation . . . is to establish rules that will ensure that all pro-competitive entry strategies may be
explored." (Local Competition Order, ¶ 12.)
   C.  Cooperation by Incumbent LECs Will Be Critical
52.  Removal of legal and regulatory barriers is enormously important to promoting local
competition, which is the key to securing the Act's goals. But Congress recognized that removing
legal barriers is only half the battle. One must also remove artificial obstacles mounted by
incumbent LECs, since all local entrants need access to certain LEC inputs.
53.   Facilities-based entrants require interconnection. A facilities-based entrant would still
require good and reasonably-priced interconnection to the LEC's public switched network.
Interconnection is vital because the essence of communication is the ability to reach and be reached
by others. Thus, telephone service exhibits such unusually strong positive "network externalities"—
the network's value to a subscriber increases greatly with the number of subscribers that can be
reached through the network. Initially an entrant will have far fewer subscribers than the incumbent,
so if networks were not adequately interconnected, customers would prefer the incumbent's even if
the entrant's network was otherwise superior.
54.  As a result, the incumbent can use ubiquity advantages that derive from control of its
installed subscriber base and bottleneck facilities as strategic weapons to stifle entry. ¹⁶ For example,

Page 19      

the incumbent might impose onerous interconnection terms or deny number portability (the ability
of customers to maintain their telephone numbers if they switch to an entrant). Overcoming such
ubiquity barriers in telecommunications would be very difficult without the aid of regulation. On
this point, economists are—quite out of character—virtually unanimous. Thus, until the incumbent's
share of subscribers is significantly eroded, even efficient facilities-based competitors will depend
on continued regulation to discipline the incumbent's interconnection terms and prices; to secure
number portability; to allow its customers to call any subscriber of the incumbent in the local area
without dialing more digits than would another subscriber of the incumbent ("local dialing parity");
and to access common signaling facilities and databases.
55.   Resellers require adequate wholesale discounts. Resellers require the incumbent's
cooperation in switching over customers and in obtaining access to various operations support
systems. In addition, since resellers undertake costly retailing functions such as marketing and
billing otherwise performed by the LEC, to succeed even an efficient reseller must obtain the LEC
services at wholesale prices discounted off the LEC's retail prices by an amount equal to the LEC's
avoided retailing costs.
56.   Partial-facilities entrants require network unbundling. Like a full-facilities entrant, a partial-
facilities entrant also requires interconnection so its subscribers can communicate with the
incumbent's. But it requires also network unbundling—access at economical pricing to that subset
of network elements it wishes to lease from the LEC. The degree of incumbent cooperation needed
to make unbundling work efficiently is probably even greater than for the other two entry modes,
since unbundling can involve reaching deeper into the network. ¹⁷
57.  The Act (§§ 251, 252) requires incumbent LECs to provide the above requisite cooperation

Page 20 .       

to all local entrants. But requiring incumbent cooperation and attaining it are two different things.
Incumbents are naturally inclined to resist any encroachment by competitors, and regulators will
have their work cut out for them in implementing the Act's requirements for promoting local
competition. Softening incumbents' resistance and inducing greater cooperation would therefore
be quite valuable. As I will show, this point is critical for developing a procompetitive BOC entry
standard.
   D.  The Potential Benefits and Costs of BOC Entry: Overview
58.  There is broad agreement that BOC interLATA entry is in the public interest once the BOC
faces sufficient local competition to eliminate its local market power. But what are the tradeoffs
from authorizing earlier BOC entry?
         1.  Potential benefits
59.  The potential benefits of earlier BOC entry are conceptually straightforward. Briefly, BOC
entry could allow realization of economies of scope, especially in retailing functions: offering local
and long-distance services jointly could produce large savings in billing, marketing, and other costs.
Moreover, it is widely believed that many consumers would value highly the simplicity and
convenience of a single bill, a single customer service representative, and other advantages of one-
stop shopping for all their telecommunications services, as well as being able to obtain new bundled
packages of such services. The BOC in its region is unusually well positioned to tap these
advantages on both the supply and demand side of joint provision because it is the dominant provider
of a key ingredient, local services, and enjoys an established reputation and customer base.
60.  In the longer run, these advantages of joint provision are not unique to the BOCs; other
telecommunications providers with established reputations (such as the major IXCs) could realize
these benefits provided the BOCs and state regulators have effectively opened the local markets to
competition as required in the Act. However, in the short run the BOCs do possess some special
advantages in joint provision (see section II.A).
61.  Aside from these benefits of joint provision, BOC entry could bring more competition in
long-distance services. The BOC is unusually well placed to provide such additional competition,
especially for residential and low-volume business customers, due to various advantages deriving

Page 21      

from its powerful brand name and established customer links in its region (see section II.C.2).
Indeed, because there are always potential benefits from letting any firm try its luck in any market,
economists' normal instinct is to avoid placing artificial entry restrictions, unless there are strong
offsetting considerations.
         2.  Potential costs
62.  In this case, however, there are offsetting considerations. It is important to understand these
potential costs in order to appreciate why BOC entry cannot be analyzed as just generic entry by any
other firm. Because the potential costs and how to best address them are less transparent than the
benefits, this affidavit devotes more attention to analyzing these issues.
63.  In a nutshell, a BOC's control over key local network inputs needed by others to compete in
local services, long-distance services, and integrated services could enable it to inefficiently handicap
rivals and distort competition in all these services. A BOC's incentives to handicap such rivals will
increase after entry, compared to its pre-entry incentives under a suitably structured entry standard.
These altered incentives can be very damaging, since regulatory (and other) oversight cannot always
secure BOC cooperation in supplying inputs to rivals as effectively as would be forthcoming if
incentives were better aligned. I outline next why BOC incentives to cooperate will diminish post
entry, then discuss the ability of regulatory oversight to enforce cooperation in the face of these
reduced BOC incentives. Section E draws out the implications for the design of a procompetitive
entry standard.
64.  Authorizing BOC entry affects BOC incentives through two main channels: (a) leverage into
long-distance and integrated services; and (b) emboldened resistance to local competition.
             a.   Leverage into long-distance and integrated services
65.   Long-distance services. The Department of Justice sought the Bell System's 1984 divestiture
of its local telephone operating companies to prevent misuse of these key monopoly local networks
to stifle competition in related markets—notably long-distance services, equipment manufacturing,
and information services—that were viewed as potentially competitive but heavily dependent on
access to these local networks. Incentives to artificially favor one's affiliates in adjacent markets
flow in large part (though certainly not entirely) from asymmetric regulation. A firm whose prices

Page 22      

are regulated at the bottleneck, as the Bell system was for local telephone services and as the BOCs
are today, has strong incentives to circumvent such regulation by favoring its unregulated (or less
tightly regulated) operations in adjacent markets. ¹⁸ The favoritism can involve cross-subsidization
(see section III.B.1.a). More importantly, it can involve non-price access discrimination—hampering
rivals' access to the bottleneck, for example, by imposing conditions that inflate rivals' costs or
degrade their quality (see section III.A.1). This enables the firm to raise its (less regulated) prices
in those adjacent markets, while distorting competition and harming consumers in the process.
66.  The choice to seek divestiture of the regulated local telephone monopolies from long-distance
segments reflected a judgment that, at that time, regulation could not—without being overly
intrusive—adequately control the myriad types of (non-price) access discrimination that a vertically-
integrated entity could employ. If allowed into long distance, BOC incentives would resurface to
attempt access discrimination against IXCs in order to circumvent regulation. Indeed, today there
may be a new motive for access discrimination, namely, to weaken the major IXCs as potential
entrants into local services; BOC entry reduces the cost to it of engaging in such behavior since lost
access revenue from reduced IXC sales is partly offset by increased BOC long-distance sales (see
section III.B.2.a). However, a BOC's ability to act on its incentives and engage in such access
discrimination is weaker today, as explained shortly.
67.   Integrated services. The ability to offer integrated services is widely emphasized as
competitively important, both due to cost savings from joint provision and to the willingness of some
consumers to pay a premium for dealing with integrated providers. The key inputs that non-BOCs
lack to offer integrated services in a BOC's region are the monopolized local services; long-distance
and other services can be readily obtained from alternative providers. A BOC's entry into long-
distance—and hence integrated services—directly reduces its incentives to supply others key
wholesale local services which they need to provide integrated services. As with long-distance
services, a main driver of BOC leverage incentives into integrated services is asymmetric regulation:

Page 23      

the BOCs are likely for some time to remain regulated in their prices for local services or inputs, but
would become unregulated (or less regulated) in retail sales of long-distance services. The wrinkle
here is that undermining competitors in integrated services by withholding from them good access
to wholesale local services could benefit a BOC beyond attempting to degrade only long-distance
access.
68.  The reasoning is as follows. Regulation is likely to be more effective in preventing a BOC
from degrading existing long-distance access arrangements than in prodding it to establish the largely
new arrangements for wholesale local services (see section I.E below and section IV). Thus,
impeding access to wholesale local services can be a more potent way for the BOC to weaken
competitors in integrated services. This in turn could be profitable for at least two reasons. (a)
Limiting rivals' ability to realize cost savings from joint provision of services also limits the
downward pressure they can exert on the BOC's unregulated prices for long-distance services. (b)
Some customers are willing pay a premium to deal with a provider of integrated services (e.g., they
value one-stop shopping); hence, a BOC could extract higher (unregulated) prices from such
customers for its long-distance services if can impede other providers of integrated services.
             b.   Emboldened resistance to local competition
69.   Local services. Promoting local competition is a key stand-alone goal of the Act (witness
the §§ 251, 252 requirements on all incumbent LECs), but one whose attainment will require
considerable LEC cooperation. Naturally, all other things being equal, the LECs are reluctant to
extend such cooperation to competitors that could threaten their local dominance (this reluctance
does not hinge on a LEC's status as subject to price or profit regulation). Providing LECs with
incentives to cooperate can greatly accelerate the process. In the case of the BOCs, the promise of
interLATA entry conditional on having first provided appropriate cooperation can be a potent tool
for enticing cooperation. This point is very important.
70.  The BOC is likely to be far better informed than regulators about how to establish the new
local access arrangements and how long this should take. Thus, authorizing BOC entry only after
the requisite arrangements necessary to open the local market are made available puts the onus in
the right place: the BOC's desire for earlier entry prods it to implement its part quicker. Conversely,

Page 24 .       

the ability to prod a BOC to implement new systems diminishes significantly once entry authority
is granted. Absent meaningful benchmarks, penalty threats are problematic, because regulators and
courts lack the information about what are reasonable implementation lags for new systems.
Authorizing BOC entry before its local market is open would thus prematurely embolden the BOC
to stiffen its resistance to opening its market.
   E.  Principles for a Procompetitive Entry Standard
71.  By itself, allowing a BOC to offer long-distance and integrated services is desirable; the
potential benefits could be substantial. The danger with premature BOC entry, however, is certainly
not that it will enhance the BOC's ability to compete; the danger is that it will allow the BOC to
impede others' ability to compete. A procompetitive BOC entry standard should strive to ensure that
all parties are given an opportunity to compete on the merits. As the FCC's former chief economist
has put it, our goal should always be to level the playing field upwards (Farrell, 1996).
72.  Given the importance of good access to BOC local networks for protecting competition in
long-distance services and for promoting it in local and in integrated services, the costs of "early"
BOC entry are likely to outweigh the benefits if regulatory and other safeguards cannot assure good
access in the face of reduced BOC incentives to cooperate. A key question therefore for developing
a procompetitive entry standard concerns the efficacy of various post-entry safeguards in enforcing
BOC cooperation.
73.  Economic reasoning suggests—and historical experience confirms (see section IV)—that the
efficacy of regulatory oversight varies widely with the economic environment. Regulation, while
never perfect, fares much better in a stable environment where information is reasonably symmetric,
than in a rapidly changing environment where informational asymmetries are greater and more
frequent adjustments are needed. Correspondingly, regulatory oversight does much better at
enforcing existing access arrangements than at overcoming incumbents' resistance to rapidly
implement new arrangements, for which the lack of historical benchmarks on what constitutes
acceptable performance gives incumbents great latitude for plausible deniability.
74.  These observations have important implications. Because access arrangements for long-
distance services have had over a decade to develop, the combination of regulation and established

Page 25      

voluntary arrangements among IXCs and LECs is likely to prevent any significant degradation of
these established arrangements. Although the necessary arrangements will certainly evolve over
time, my understanding is that radical changes in access arrangements governing the majority of
interexchange revenues are not imminent. The evidence thus suggests that, when weighed against
the potential benefits of BOC entry, the threat to long-distance access arrangements from allowing
BOC entry is tolerable in the short run. ¹⁹
75.  The picture is quite different regarding access arrangements for local competition. These
arrangements—for interconnection and, especially, for network unbundling and total service
resale—are largely new and untested. Implementing them will require substantial cooperation by
incumbent LECs in developing a host of new technical, operational and business protocols, and in
establishing appropriate prices. Incumbents will have wide latitude to stall the process by foot
dragging, slow rolling, and otherwise withholding cooperation. "Sins of omission" of this sort are
especially difficult for outsiders to detect and prevent, since there is no historical benchmark to guide
what is possible and to gauge deviations from this norm. Thus, local competition will evolve more
expeditiously and more efficiently if the BOCs have greater incentives to cooperate in putting in
place the new access arrangements needed to open their local markets to competition.
76.  An appropriately structured interLATA entry standard can play a major role in stimulating
BOC cooperation. One should harbor no illusions: incumbent LECs have great latitude to help or
hinder the evolution of local competition, and a suitable BOC entry standard can elicit much more
BOC cooperation in establishing and properly pricing the key new arrangements.
77.   On the other hand, once the major new arrangements have been established and shown to be
commercially operable, and once reasonable prices for them have been set, a track record is created
for what constitutes "good performance." Post-entry safeguards—regulatory, antitrust and
contractual—then become more effective at countering BOC attempts to reduce cooperation, since
the performance benchmarks can help enforcers to prevent future backsliding and to extend these

Page 26      

arrangements to other regions or other entrants. ²⁰ Thus, authorizing BOC entry only after the major
new access arrangements are in place—or demonstrably made available—can cement important
steps to irreversibly open local markets to competition.
78.  It is important, however, that these new access arrangements be demonstrated to work on a
commercially significant scale, under real-world strains; arrangements that exist only on paper or
have not been meaningfully tested do not provide much comfort. As with any new ventures, there
will be inevitable growing pains; it is important to iron out the kinks while the BOC is still relatively
inclined to cooperate—that is to say, before interLATA entry has been authorized. The § 271 entry
authority thus is a potent one-time measure that, if properly used, can achieve a real advance in local
competition—with favorable effects also on competition in integrated services, and in the longer run
also on competition in long distance.
79.  Weighing the potential benefits and costs of BOC entry leads me to advocate the following
entry standard: BOC interLATA entry should be authorized only if there is sufficient confidence that
the local market in the state has been irreversibly opened to competition. Authorizing earlier entry
would raise serious competitive concerns; while delaying entry once the local market is open would
unnecessarily deprive consumers of potentially large benefits. This open-market standard does not
require the presence of effective local competition of all forms and in all regions of the state; the Act
aims to let market forces determine what modes of competition work best and where, and regulatory
and other safeguards will still play a role in preventing abuse of BOC market power. But it does
require considerably more than paper compliance with the competitive checklist.
80.  By far the best test of whether the local market has been opened is observing the emergence
of meaningful local competition. Local competition establishes presumptions; the more widespread
and varied it is, the greater our confidence that the local market has been irreversibly opened. Use

Page 27 .       

on a commercial scale of the new access arrangements needed to support all three local-entry modes
envisioned in the Act—facilities-based, unbundled elements, and resale—demonstrates that
competitors are obtaining what they need. If sufficiently diverse competition fails to develop, it is
important to understand why. An absence of sufficient competitive entry calls for skepticism in
approving an entry application, requiring offsetting evidence that the absence of competition reflects
lack of interest by entrants. In the absence of such a showing, the presumption would be that the
market has not been irreversibly opened. For reasons sketched in the earlier Summary and explained
further in section V.D, the main requirements for an open market are: full, meaningful
implementation of the major new technical and operational access arrangements for local
competition; adequate assurance that BOC prices are reasonable and cost-based and will continue
to remain so after interLATA relief is granted; and removal of major state regulatory or other
artificial barriers that are likely to significantly delay local competition.
81.  The remainder of this affidavit fleshes out the basis for these conclusions. Section II
discusses the likely benefits from early BOC entry. Section III discusses the competitive concerns,
and section IV addresses the efficacy of regulatory and other post-entry safeguards in counteracting
these concerns. Section V elaborates on the requirements needed to determine that the local market
is irreversibly opened to competition, and concludes that the Justice Department's entry standard
correctly incorporates these requirements and therefore serves the public interest in promoting
competition.

II.   Potential Benefits of BOC Entry
82.  There are potentially significant benefits from early BOC interLATA entry. The argument
rests on two points: (1) BOC entry can bring certain efficiencies; and (2) these efficiencies cannot
be attained by other providers as fully or expeditiously without BOC entry (if they could, BOC entry
would not be necessary). Step (2) arises because the BOCs today would possess certain unique
advantages in providing integrated services; and because the Act ties the removal of certain
constraints on the ability of other firms to compete to the approval of BOC interLATA entry. The
resulting potential benefits from BOC entry include: A) cost savings and introduction of new

Page 28 .       

integrated services, made possible by joint provision of local and long-distance services; B)
increased competition in intraLATA toll services in states that now lack dialing parity; and C)
increased competition in interLATA services.
   A.  Joint-Provision Efficiencies: Cost Savings and New Integrated Services
83.  The efficiencies from jointly providing local and long-distance services largely involve: (a)
on the supply side, the cost savings from joint retailing of services; and (b) on the demand side, the
value to consumers of one-stop shopping and other new integrated services.
         1.  Cost savings
84.   Technological economies on the network side exploitable only through BOC interLATA
entry seem modest. First, IXCs' network costs are only a relatively small share of their total cost of
providing long-distance services, so there is only relatively little cost to cut; several BOCs
reportedly have signed contracts with IXCs to lease wholesale long-distance capacity at prices
between 1 and 2 cents per minute. ²¹ Second, the separate affiliate requirement in § 272, aimed at
combating cross-subsidization and discrimination, appears to preclude network integration and
therefore to restrict attainment of network economies in providing local and long-distance services,
to the extent such economies did exist. Finally, I am not aware of compelling evidence that
significant such economies do exist. Consistent with these arguments that the economies exploitable
on the network side are only modest, various BOCs plan to offer long-distance services—at least
initially—not by expanding their own facilities but primarily by leasing wholesale IXC capacity.
85.   Retailing economies however do appear significant. Offering an additional service (i.e., long-
distance) to existing customers entails lower incremental costs of marketing, billing, customer

Page 29      

service, and other retailing functions than the corresponding costs of providing that service alone. ²²
A BOC offering long-distance services could plausibly realize cost savings in these retailing
functions of around 2 to 2.5 cents per minute compared to an IXC that is not providing integrated
services (see discussion below, however). Taking the average price of a domestic interLATA call
to be roughly 13.5 cents, this would represent a 15%-19% savings.
         2.  New integrated services
86.  Quite aside from cost savings, joint retailing of local and long-distance services can provide
direct benefits to consumers, akin to obtaining a new, higher-quality product. Consumers therefore
could benefit even if the prices of the underlying services did not fall due to cost savings.
Consumers are said to value highly the convenience and simplicity of one-stop shopping and other
advantages offered by an integrated services provider. The impressive success of GTE and other
non-BOC LECs at capturing long-distance business, sometimes without undercutting IXCs' prices,
attests to the importance of offering integrated services. ²³ If provided interLATA authority, a BOCs
could make available the benefits of such integrated services to consumers in its service regions.
         3.  The ability of other carriers to attain these efficiencies
87.  A BOC, if allowed interLATA entry, would currently enjoy certain advantages over most or
all other carriers in the joint provision of telecommunications services in its region: (a) its
established brand name allows it to market additional telecommunications services at relatively low
costs of advertising and promotion; (b) its existing relations with virtually all local subscribers

Page 30 .       

allows it to offer billing and customer service for added services at relatively low cost; (c) partly for
these reasons, it can obtain lower wholesale prices for long-distance capacity from IXCs than can
others; and, most importantly, (d) its control of local networks makes it the dominant source of key
local services needed to offer integrated services.
88.  The largest IXCs similarly enjoy strong reputations and established customer relations with
telephone subscribers in the BOC's region. Thus, they could match many if not all of the efficiencies
deriving from (a) and (b), provided they could obtain comparable access to (c)—the key local
services now controlled by the BOCs. ²⁴ The Act, of course, requires all incumbent LECs to provide
such access to wholesale local services; however, delaying BOC interLATA entry until such
comparable access has been secured would delay the advent of benefits from joint provision. The
basic reason is that implementation and proper pricing of access to the various new wholesale local
services required by the Act will take time. ²⁵ Thus, there is a benefit side to allowing early BOC
entry. (The cost side of authorizing BOC entry before certain market-opening measures have been
implemented is discussed later.)
   B.  Increasing the Competition in IntraLATA Toll Services via Dialing Parity
89.  Section 271(e)(2)(B) of the Act prohibits a non-excepted state from requiring a BOC to

Page 31 .       

implement intraLATA toll dialing parity before February 1999 unless the BOC is authorized to offer
interLATA services in the state. ²⁶ Section 271(e)(2)(A) requires a BOC to implement intraLATA
toll dialing parity when it begins offering interLATA services. Thus, BOC interLATA entry would
indirectly boost competition in intraLATA toll services by triggering dialing parity; such dialing
parity has proven to be very important for stimulating intraLATA toll competition. In Minnesota,
for example, competitors have captured over 30% of the market since toll parity was implemented
in February 1996.
   C.  Increasing the Competition in InterLATA Services
90.  The argument for why BOC entry would increase competition in interLATA services rests
on three premises. First, interLATA markets exhibit imperfect competition. Second, the BOC is
uniquely positioned to offer increased competition (otherwise other entrants would do just as well).
Third, BOC entry indeed would bring such competition.
         1.  Competitiveness of interLATA markets
91.  The extent of interLATA competition is hotly contested. BOCs and their experts characterize
it as "anemic" and "tacit collusion" while IXCs portray it as "robust" and "intensely competitive." ²⁷
It is helpful to review some salient points.
92.   Market Structure. Supply of interLATA services is quite concentrated: in 1995, AT&T
accounted for about 53% of revenues, MCI for 18% and Sprint for 10%. On the other hand,
concentration has declined considerably since divestiture (when AT&T's share of market revenue
was over 90%) and is continuing to decline. Four carriers have national networks (AT&T, MCI,
Sprint, and WorldCom) and at least one more national network is being assembled; many carriers

Page 32      

have regional networks; and there are hundreds of resellers. The market share of carriers other than
AT&T, MCI and Sprint has grown from under 12% in 1991 to over 19% in 1995, ²⁸ and, as the FCC
observed in October 1995 when finding AT&T non-dominant, these carriers exert considerable
competitive discipline. Nevertheless, the growth of independents is in theory consistent with
supracompetitive ("umbrella") pricing by the majors. In gauging competition therefore one must,
as usual, look beyond concentration and other aspects of market structure and examine performance.
93.   Performance. Crandall and Waverman (1995, chapter 5) survey the literature on interLATA
competition and remark: ". . . existing studies. . . are not particularly convincing and do not lead to
a single conclusion" (p. 165). This literature has generated so much heat but remarkably little light
for reasons of data limitations ²⁹ and methodological problems. ³⁰ Crandall and Waverman perform
additional analysis using interLATA intrastate data, which offers more observations than interstate

Page 33      

data (there are 38 multi-LATA states but only one national jurisdiction), and more sophisticated
estimates of quantities. They find that between 1987 and 1993 prices fell much more than access
charges; prices net of access fell 4% per year by one estimate (pp. 156-7). Moreover, the data used
(tariffs, for peak period, switched five-minute calls) fail to capture the impact of various discount
plans. Finally, while falling prices could be due to non-competition factors, such as technological
cost-reductions, there are other signs of increased competition. Notably, the narrowing of dispersion
in prices of calls (a) across states for a given distance, and (b) across different distances suggests that
competitive pressures are pushing prices to more closely track costs (pp. 151-3).
94.  Crandall and Waverman's overall assessment is that the interLATA market displays
"considerable competition" that is "more vigorous than that predicted by the Cournot model" (p.
163) and that "has been effective in reducing prices" (p. 132). However, they add that "(interLATA)
markets are not fully competitive so that further entry would be of real value" (p. 132). I share this
overall assessment. Allegations that interLATA price competition is nonexistent defy common
sense: if there is no competition, why do so many customers switch back and forth between carriers
each year? ³¹ More likely, of course, is that there is considerable competition not captured in
published price data, such as the familiar $50 or $100 checks as inducements to switch between
carriers. On the other hand, though competition exists and is increasing, ³² there is surely room for
more competition. ³³
         2.  BOC Advantages over other long-distance entrants
95.  A BOC in its region enjoys significant efficiency advantages over other potential entrants into

Page 34      

long-distance services. It stretches credulity to argue—as some have—that a BOC has nothing
uniquely positive to offer, for example, that if it leases others' facilities to provide long-distance
services then it is no different from the hundreds of existing resellers.
96.  A BOC's reputation and established billing and customer service arrangements with local
subscribers would enable it to market long-distance services more effectively than could other
entrants. A BOC would be especially well placed to address lower-volume customers. First, billing
and other "fixed and common costs" of serving a customer are relatively large compared to the
revenue from low-volume customers, and a BOC already incurs most of these costs in providing
local service. Second, low-volume customers are often reluctant to switch from a major IXC to an
unfamiliar vendor, and a BOC in its region is often the only carrier with a comparable reputation to
those of the major IXCs. ³⁴ These advantages which would render the BOC a powerful retailer of
long-distance services also enable it to obtain wholesale long-distance capacity from IXCs at
unusually low prices, further increasing its cost advantage over other potential entrants into retail
long-distance services.
         3.  How much competition will BOC entry in fact add?
97.  The flip side of the BOC's unique advantages, however, is that the BOC may not feel
compelled to pass through most of its competitive advantages to consumers. For example, a BOC
may elect to pass on to consumers only a fraction of the unusually large discounts it obtains from
IXCs on wholesale long-distance capacity. The degree of pass-through is important: it not only
influences the distribution of gains between the BOC and consumers, but also influences the degree
to which long-distance calling volume will increase, which in turn affects the gains to society from

Page 35 . .       

BOC entry. ³⁵ Precisely how much a BOC's entry will (a) lower prices or (b) largely reshuffle profits
from IXCs is an open question. Those who argue that BOC entry will greatly lower prices by
increasing competition must explain why—if the long-distance market is far from competitive
despite the presence of several major IXCs—adding one (albeit potent) competitor in the state would
radically alter matters.
98.  In my opinion BOC entry would not yield as dramatic an increase in competition as some
claim, in part because of the rapid increase in competition that is already occurring. ³⁶ Nevertheless,
some further price declines can be expected from BOC entry. Still greater benefits are likely from
joint provision of local and long-distance services (cost savings, availability of new integrated
services), whose advent would be delayed by delaying BOC interLATA entry. However, authorizing
BOC interLATA entry before the local market has been opened to competition also carries
competitive risks; to these I now turn.

III.  Potential Competitive Concerns Raised by BOC Entry
99.  Section A below discusses more comprehensively the various practices a BOC might employ
against long-distance carriers or local entrants, and section B why BOC incentives to do so will
increase post entry. Section C addresses whether BOC entry would be inefficient solely because
BOC access prices to IXCs, with whom BOCs would compete, are well above BOC costs of
providing such access.
   A.  Anticompetitive Practices: Access Discrimination and Exclusionary Pricing

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100.  In various ways, both long-distance carriers and local entrants depend on good access to a
BOC's ubiquitous local network. Control of these vital local inputs gives a BOC an unusual ability,
if unchecked by regulation, to engage in anticompetitive practices. It is useful to distinguish between
exclusionary practices that involve non-price terms of access to a BOC's facilities ("access
discrimination") and those that involve prices—because the welfare effects of the two sets of
practices can differ, as can the incentives to engage in them.
         1.  Access discrimination
101.   Types of practices. A BOC could impede the ability of rivals to compete by misusing its
control of the local network in various ways. It might raise competitors' costs, for example, by
imposing unnecessarily costly requirements for network interconnection or providing them inferior
support or maintenance functions. Increasing competitors' costs induces them to raise prices and
thereby indirectly diverts retail sales from competitors to the BOC or its affiliate. A BOC might also
divert demand away from competitors and towards its affiliates directly, without forcing them to
raise prices. This might be done by degrading competitors' quality, such as by foot-dragging in
providing new access arrangements, or by appropriating competitively sensitive information about
customers obtained in the course of supplying rivals with bottleneck inputs. I will label all these
non-price methods to weaken rivals—both in long-distance and in local services—under the general
rubric of "access discrimination."
102.   Inefficiencies. Access discrimination is a particularly inefficient form of rivalry. Raising
competitors' costs is directly harmful, even if it does not lead to higher prices. In fact, prices are
likely to rise; this both harms consumers, and creates additional social losses from output reduction.
Degrading competitors' quality too is directly inefficient, harming both competitors and consumers.
In addition, these practices and the misappropriation of competitively sensitive information
could—by weakening competitors or discouraging entry—reduce the variety of products available
the other innovations that competitors might bring to a market. These inefficiencies will be borne
by both competitors and consumers.
         2.  Over-pricing of inputs
103.  Overpricing of inputs needed by competitors, or of outputs that are complementary to those

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sold by competitors, also is inefficient. The social harm here occurs not because of the high prices
themselves but because these high prices inefficiently reduce the quantities purchased. However,
setting prohibitively high prices for bottleneck inputs, such as call termination, is tantamount to
refusing to supply such inputs and thus can create inefficiencies of comparable magnitudes to those
under access discrimination. Steep overpricing of inputs can be seriously anticompetitive even well
short of complete exclusion of rivals: by greatly inflating rivals' costs, it can artificially and
significantly depress their market presence.
         3.  Under-pricing of outputs
104.  BOC entry conceivably could stifle competition also by giving the BOC a new
instrument—charging artificially low prices for long-distance services. The arguments can be
usefully grouped into three categories, that differ in their plausibility and welfare effects.
105.  The first is predatory pricing or variants thereof: a BOC would set prices temporarily low
in order to stifle competition and subsequently raise prices. ³⁷ Economists are somewhat skeptical
of predation arguments, especially when some rivals are well-financed corporations such as the
major IXCs, absent regulatory cross-subsidy.
106.  The second argument invokes such cross-subsidy. A BOC may set an artificially low price
that could be profitable to the BOC whether or not price can be subsequently raised in the targeted
market; such behavior could be profitable because it entails cross-subsidy from the BOC's regulated
activities. As such, it also is inefficient. Section B.1.a below addresses this argument, concluding
that cross-subsidy incentives are likely to be weaker for the BOCs today due to increased reliance
on price caps and other "incentive regulation."
107.  The third argument does not invoke predation or cross-subsidy, but a price squeeze. Because
a BOC charges IXCs access prices well above its costs, it has an artificial advantage in competing

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with IXCs for long-distance services. This argument is evaluated in section C.
   B.  Why BOC Entry Increases Anticompetitive Incentives
108.  It is helpful to distinguish anticompetitive incentives driven by attempts to circumvent
regulation of price or profit, from incentives that do not hinge on the presence of regulation.
         1.  Regulatory Evasion
             a.   Cost misallocation ("cross-subsidization")
109.   Incentives and methods. Traditional U.S. regulation of public utilities, including local
telephone companies, was known as cost-of-service or rate-of-return regulation, because prices were
intended to offer the firm a reasonable opportunity to cover its costs including a fair rate of return
on capital. A firm whose prices are regulated in such a manner and which also has unregulated (or
more lightly regulated) operations in competitive markets will have incentives to shift profit from
the regulated to the unregulated side: the higher profit earned by unregulated operations flows
directly to shareholders, while the lower profit of the regulated side allows it to "justify" requests
for higher allowable prices. Such profit shifting can occur by misallocating various costs of the
unregulated entity to the regulated one, behavior more commonly known as "cross-subsidization." ³⁸

110.   Anticompetitive effects. The incentives to engage in cost misallocation stem from a desire
to circumvent regulation; but such behavior can have incidental effects of distorting competition.
Overpaying an affiliate for its services artificially favors it in competing for sales to the regulated
side; misallocating the affiliate's costs to the regulated side (and thus ratepayers) favors it in
competing for outside customers by artificially reducing its costs and thereby allowing it to set

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artificially low prices. These competitive distortions mean that winners are no longer determined
on the merits. ³⁹
111.   Accounting safeguards and separate subsidiaries. To help detect and prevent cost
misallocations, regulators often subject firms to detailed accounting safeguards and sometimes
require that unregulated, competitive activities be undertaken through separate subsidiaries. Section
272 of the Act imposes such requirements on BOCs wishing to offer long-distance services.
Although such safeguards have some bite, it is widely acknowledged that they have not eliminated
cost misallocation in the past, and it is naive to believe they could do so in the future if the firm has
strong incentives to engage in cost misallocation.
112.   Price cap regulation. Importantly, however, the BOCs argue that incentives to misallocate
costs no longer exist because in recent years the FCC and state commissions have moved from
traditional cost-of-service regulation towards pure price-caps, that sever the link between a firm's
allowable regulated price and its costs. Cost misallocation then loses its purpose, because higher
reported costs for the regulated side no longer yield higher prices.
113.  These claims overstate the extent of the regulatory changes, for two reasons. First, traditional
regulation exhibited some lag between rate cases, during which period prices were not continuously
adjusted towards cost. Second, today's regulation does not—and cannot— amount to pure price
caps. Price caps can never be pure, but are periodically revised. ⁴⁰ In addition, some schemes of

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"incentive regulation" do not involve price caps, but require adjustment of prices to share profits (or
losses) with consumers once profits are outside certain specified bands. Therefore, a regulated firm's
allowable future prices will ultimately depend on its past costs, which re-introduces some incentives
to engage in cost misallocation.
114.  Nevertheless, these regulatory changes do seem to have markedly altered BOCs' incentives.
The BOCs have embarked on aggressive cost-cutting programs, which financial analysts and others
attribute to the regulatory changes. ⁴¹ These efforts suggest the BOCs assign some credibility to the
new regulatory promises. But in that case, they also would not seem to have a strong basis for
counting on regulators to allow rapid price increases beyond stipulated levels in response to
increased costs due to cost misallocation (or other reasons). ⁴² In short, incentives to engage in cost
misallocation are certainly more attenuated today, which also serves to lower the risks of the BOCs
engaging in anticompetitively low pricing.
             b. Leverage incentives due to asymmetric regulation
115.  A different and more serious anticompetitive incentive involves leveraging of market power
from the price-constrained bottleneck to adjacent, unregulated markets, by engaging in the myriad
forms of (non-price) access discrimination. As was explained in section I.D.2, incentives for
leverage stem in large part from asymmetric regulation: the firm's prices for bottleneck services are
regulated, but its prices for other services that rely on the bottleneck services are not regulated (or
less tightly regulated). Here it is worth clarifying a few points.
116.  First, contrary to some claims, access discrimination is not costless to a BOC since it reduces
BOC input sales to the targeted carriers. ⁴³ Nevertheless, a BOC generally will have some incentives

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to attempt access discrimination if it is selling unregulated services that compete with those offered
by firms that depend on its regulated inputs. And unfortunately the more stringent is price regulation
of the firm's bottleneck inputs, i.e., the more "successful" is price regulation, the stronger is the
incentive to attempt access discrimination.
117.  Second, § 272's requirement that a BOC sell its long-distance services only through a
separate affiliate by itself does little to dilute a BOC's incentives to attempt access discrimination
against the affiliate's competitors (e.g., IXCs)—because the affiliate's and parent's profits accrue
to common shareholders. Regulators can dilute the common interests of a firm's different units by
imposing further requirements, e.g., that managers be rewarded based only on the performance of
their units, not of the overall firm; they also can attempt to block avenues of discrimination. But to
eliminate all incentives and ability to favor affiliates would require eliminating all commonality of
interest (including via personnel rotation or central oversight) and sharing of resources. This would
require not separate affiliates but separate firms. ⁴⁴ Thus, as long as a BOC is subject to asymmetric
price regulation, incentives will persist to attempt access discrimination for purposes of leverage.
118.  Finally, it is worth stressing that motives of leverage into integrated services—once a BOC
has secured interLATA entry and thus may offer also integrated services—would drive a BOC to
reduce cooperation not only in providing access for long-distance services, but also for the host of
new wholesale local services needed by integrated-services competitors and called for by the Act.
         2.  Protecting the core local market
             a.   Reduced cost of harming IXCs to delay their local entry
119.  The major IXCs are among the most likely large-scale potential entrants into local markets.
Through access discrimination, a BOC may be able to damage the IXCs' reputations in its region and
reduce their customer base, thereby also delaying their entry into its local markets. Long-distance

Page 42 .       

entry lowers a BOC's cost of pursuing access discrimination, because while the BOC loses access
revenue due to reduced sales of IXCs, some of these reduced sales are now diverted to the BOC's
affiliate instead of being lost altogether. ⁴⁵
             b.   Reduced incentives to cooperate with local entrants
120.  Finally and importantly, a BOC's incentives to cooperate with local entrants would be
inadequate even putting aside leverage motives into adjacent markets (as would be relevant if
integrated services were unimportant, and if regulation could perfectly prevent access discrimination
against IXCs). Like any dominant incumbent a BOC is inclined to resist entry, because dominance
in providing even purely local services is profitable, notwithstanding regulation. ⁴⁶ At the same time,
the BOC could value entry authority into long distance; for example, its strong brand name locally
and ability to realize cost savings through joint retailing functions could allow it to earn profits in
long distance (section II.C). Therefore, to receive long-distance authority it would be willing to
extend some cooperation to local entrants. Granting such authority before the local market is open,
however, will prematurely reduce the BOC's incentives to continue cooperating in opening its
market.
   C.  Artificial Cost Advantage in Competing for Long-Distance Services

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121.  Among the concerns voiced by major IXCs is that a BOC would have artificial cost
advantages in competing for long-distance business because their access prices to IXCs are well
above cost. ⁴⁷ The IXCs are right that even if imputation rules required a BOC to charge its affiliate
the same access price as it charges IXCs, an affiliate would treat such a price as merely an internal
transfer, and would try to base its retail prices on the true cost of obtaining access. ⁴⁸ A BOC's
affiliate would then be able to undercut IXCs' prices selectively to certain customers and capture
such business even if it is inherently less efficient than IXCs.
122.  The IXCs' argument is correct as far as it goes. But it overlooks the fact that selective
discounts by a BOC could well increase total long-distance output and benefit consumers. One must
be clear about the alternatives being compared. Assuming that access charges by BOCs to IXCs
would be no higher if BOC entry is authorized than if it is not, an assumption discussed below, a
BOC's ability to offer selective discounts should increase total long-distance output and benefit long-
distance consumers, as compared with barring BOC entry. (This assumes that BOC entry does not
induce IXCs to exit the market as a result of being unable to profitably operate at a reduced scale;
if exit does occur, a BOC may be able to raise price.) The basic reason is that IXCs' cost has not
increased—because by assumption access prices are no higher—but a new competitor (the BOC)
enjoys lower cost of serving the long-distance market (albeit artificially lower, because it charges
to IXCs access prices well above its own incremental cost of providing access, while basing its own

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retail pricing behavior on the latter). ⁴⁹
123.  The assumption that regulation will prevent a BOC from subsequently raising access prices
to IXCs (or failing to lower them as much as would otherwise have occurred) is important, however.
In particular, there are dangers of regulating access pricing by including in a common basket both
access services "sold" to the BOC's affiliate and to IXCs and subjecting the basket to an overall price
cap. By lowering the price to its affiliate a BOC would then be allowed to raise prices to IXCs
while adhering to the cap; the BOC gains, of course, since the additional profits earned by its
affiliate are unregulated. Thus, a BOC will have strong incentives to try and give its affiliate
preferential discounts, in order to justify raising the access prices charged to IXCs.

124.  The Act and current regulation prohibit such discrimination in access pricing. However, a
BOC may plead "nondiscrimination" by designing discounted offers that are nominally available to
all but are targeted to its affiliate. It can make discounts conditional on terms that (a) are alleged to
provide cost savings and (b) are contrived such that the affiliate is more likely to accept, for example,
a buyer's agreeing to make very long-term purchase commitments. ⁵⁰ The scope for such
gamesmanship can be reduced by having separate price caps for access services sold to competitors
and to affiliates. And in general, if competitively significant "nondiscriminatory" discounted offers
are disproportionately accepted by affiliates, some scrutiny may be warranted of whether discounts
reflect genuine cost savings. ⁵¹

Page 45 . .       

125.  In sum, I would be reluctant to advocate delaying a BOC's interLATA entry solely on the
grounds that its access prices to IXCs are currently well above its incremental cost—as long as the
BOC can adequately be prevented from raising access prices to IXCs post entry. ⁵² It is certainly true,
however, that the best course is to reduce access charges closer to cost. Assuming that (non-price)
access discrimination could be prevented, reducing access prices would both expand downstream
output and prevent distortion of competition.

IV.  The Ability of Regulatory Safeguards to Negate Concerns Raised by BOC Entry
126.  Based on the preceding analysis, the main potential competitive concerns raised by BOC
entry are access discrimination against long-distance carriers and, especially, the withholding of
cooperation in implementing and pricing appropriately the various new wholesale local services.
How serious these potential concerns in fact are depends on how effectively and expeditiously they
can be addressed by regulatory and other safeguards. Section A below discusses generic
shortcomings of regulation, showing by implication that there is real value to having a BOC be more
disposed to cooperate than having to rely exclusively on forcing its cooperation. Nevertheless, while
never perfect, regulatory and other safeguards are far more adept at preventing degradation of
established access arrangements than at forcing implementation of new arrangements; this difference
has key implications for the design of a pro-competitive standard for BOC entry (see section V).
Sections B and C document this difference drawing on past experience with LEC behavior.
   A.  Generic Shortcomings of Regulation, and Existing vs. New Arrangements
127.  Regulation faces several inherent shortcomings in trying to curb a firm's incentives to
discriminate against competitors, which caution us against relying on it exclusively. ⁵³

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         1.  Generic shortcomings of regulation
128.   Detecting abuses. In order to be effective, regulators must be able to detect a violation. This
requires knowing, among other things, what the firm actually did (not what it claims) and often what
alternatives it could have pursued. Outsiders such as regulators, courts, and even competitors
possess vastly inferior information than the firm about its business environment and conduct. And
while a regulator can learn a great deal by consulting with interested industry parties, to eliminate
the informational disadvantage entirely the regulator would have to become the firm.

129.   Proving abuses. Detecting a violation is not the same as being able to prove it. Regulated
firms enjoy—for good reasons—procedural safeguards including the right, which they often exercise,
to challenge regulatory decisions in court. A non-specialist court is likely to be less informed about
conditions in the industry than is a regulator, and the adversarial court proceedings offer the better-
informed firm ample opportunity to raise various objections. Thus, even if a regulator is convinced
there is a violation, proving it to the standard needed to take corrective action may be too costly or
simply not feasible.
130.  The issue of proof is important. The BOCs have repeatedly argued that preventing
discrimination is easy because a service difference great enough to influence the behavior of
customers assuredly would be detected by competitors and by regulators. However, simply showing
such a difference is not sufficient to prove a BOC has discriminated, especially with new or
customized arrangements—there could be "innocent" explanations with a sufficient ring of
plausibility (different circumstances of transactions, events beyond the firm's control, etc.). Indeed,
a major advantage of competition over regulation in taming market power is that a competitor is not
constrained by the same rules as a regulator: if a competitor believes the incumbent's price is
excessive or its service is inferior it can simply offer customers better options—without having to
prove to anyone that the firm is misbehaving.
131.   Deterring abuses. Effective deterrence requires the expected penalty to exceed the expected

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gain from engaging in an abuse. The requisite penalty may have to be large given (a) the potentially
large gains to a firm and (b) the limited chance that a violation will be detected and proved, hence
that the penalty will be imposed. Regulators may not always have the legal rights or the political
ability to impose penalties large enough to achieve meaningful deterrence. Imposing high penalties
is especially problematic when violations are not demonstrably blatant, as is likely with new (as
opposed to established) access arrangements.
132.   Correcting abuses. Since deterrence will not be perfect, a regulator also must be able to
rectify the effects of abuses quickly and effectively. But the damage to a competitor imposed, for
example, by technical discrimination can be difficult to reverse: discrimination may have allowed
the regulated firm to beat the rival to market with a new product. This first-mover advantage could
have a durable impact, for example, if consumers would have to incur significant switching costs
should they wish to move to the entrant. (For this reason, the Act tries to minimize these costs
through such means as requiring number portability.)
133.   Cost-effective regulation. Finally, regulation would have to accomplish the above tasks in
a cost-effective manner. It does little good to prevent abuses if doing so means intruding into the
firm's decisions to a suffocating degree, or expending vast resources on regulation. As a practical
matter, the resources made available to regulators may limit their ability to engage even in the
efficient degree of oversight. The FCC and state commissions are operating under tight budgetary
and personnel constraints that may not be commensurate with their responsibilities: the new Act has
vastly increased the FCC's duties, and state commissions must grapple also with the rapidly
changing electric utility industry.
         2.  Existing vs. new arrangements
134.  Assuring equal access to BOC local networks—for both long-distance carriers and local
competitors—in the face of reduced BOC incentives to cooperate requires policing against sins of
commission and omission: a BOC might attempt to reduce cooperation from existing levels by
degrading existing access arrangements, or fail to provide a greater level of cooperation as it should
in establishing new arrangements.
135.  It is difficult for regulators to eliminate entirely even sins of commission—the degradation

Page 48 .       

of existing arrangements. ⁵⁴ Nevertheless, once arrangements are in place and there is some track
record against which to benchmark "good behavior," preventing access discrimination becomes
much more manageable.
136.  Conversely, enforcing the implementation of new arrangements is much harder. It is
particularly difficult to prevent such sins of omission, since there are no good historical benchmarks
to guide what is feasible for the firm. Implementing the new Act's local-competition requirements
of interconnection, unbundling and resale will require dramatic and wide ranging changes in the way
a LEC does business. For example, loop unbundling will require physical (not just electronic)
changes. And new electronic interfaces will be needed to coordinate ordering, billing and other
functions for carriers that resell a BOC's local service. With reduced incentives to cooperate once
allowed into long distance, a BOC could delay such arrangements considerably. It may initially
refuse to provide a new arrangement, citing prohibitive costs; then relent and "merely" delay or give
priority to requests from its affiliate to place it at a competitive advantage. The point is not that such
excuses are never true, but that it will be difficult for regulators to discern which are true and which
are not.
   B.  Enforcing Existing Access Arrangements
137.  By and large, the U.S. experience with participation by regulated LECs in long-distance
markets suggests that once access arrangements for competitors are established, subsequent problems
become much more manageable. To cite a recent example, IXCs have made substantial inroads
competing for intraLATA toll services in states such as Minnesota and Alaska that had implemented
intraLATA dialing parity prior to the 1996 Act. I am not aware of backsliding by LECs on providing
such dialing parity.
138.  It is of course possible that we have yet to see the full arsenal of incumbent responses;
intraLATA dialing parity is a recent phenomenon and incumbents may still be mulling their options.

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However, certain LECs such as Rochester Telephone (which is part of Frontier), United (which is
part of Sprint) and Lincoln Telephone were not subject to the MFJ and have offered long-distance
(interLATA) services in competition with IXCs for some time. I understand that IXCs have made
few complaints against these LECs about degradation of existing access arrangements.
139.  More recently, Sprint has owned Centel in Nevada since 1992, yet IXCs have made no
significant complaints to Nevada regulators. Southern New England Telephone Company (SNET)
has begun offering interLATA service jointly with its local service; so has GTE since the passage
of the Act (which ended the consent decree that prevented GTE's local operating companies from
jointly marketing long-distance services). GTE and SNET have been very successful in capturing
long-distance business, but neither has elicited serious complaints concerning their degradation of
existing long-distance access arrangements for IXCs.
140.  In short the scope for a BOC, after allowed interLATA entry, to degrade existing access
arrangements used by IXCs is relatively limited in the short run. Most importantly, regulatory and
antitrust safeguards can do a far better job of enforcing such existing access arrangements given the
long track record of experience with them. In addition, a BOC would face some technical difficulties
today in finely targeting for discrimination only pieces of the network that serve IXCs or their
customers. Finally, some of the markets which the BOCs are said to target if allowed interLATA
entry, low- to medium-volume residential and business customers, are also ones where IXCs require
relatively simpler access arrangements. ⁵⁵
   C.  Implementing New Access Arrangements
         1.  IntraLATA toll dialing parity
141.  The main long-distance markets in which the BOCs have participated since the MFJ are those
for intrastate, intraLATA toll services. Dialing parity—the ability to reach a carrier other than the

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LEC without dialing additional digits—is very important to subscribers who must dial manually,
such as most residential subscribers and small businesses lacking a PBX. Indeed, LECs consistently
opposed dialing parity on the grounds that implementing it would cause them to lose massive
amounts of traffic. Until a few years ago, no BOC provided dialing parity anywhere. Often
regulators did not seek to enforce dialing parity (partly on grounds of protecting this LEC revenue
in order to support cross-subsidies of other services such as basic residential access and most
services in rural areas). But even where they did, incumbents successfully delayed the process
through protracted appeals.
142.  The case of Minnesota is instructive. ⁵⁶ The Public Utilities Commission (PUC) determined
in October 1985 that dialing parity to IXCs for intraLATA toll calls (through "1+ presubscription")
was in the public interest, and in November 1987 created a committee to develop an implementation
schedule and a means of paying the costs of presubscription