Rewriting the Book on Phone Rates
Charlotte Ford’s cubbyhole of an office hardly looks like a place where history is being written. But it is there, nonetheless, that the 36-year-old administrative law judge distilled, from thousands of pages of sometimes gnarly testimony, what may be the most far-reaching regulatory proposal ever made by the California Public Utilities Commission.
What Ford has wrought on behalf of her bosses--the five utilities commissioners appointed by Gov. George Deukmejian--is a 361-page blueprint to overhaul regulation of the state’s two biggest local phone companies, Pacific Bell and GTE California.
One virtually certain result of this proposal, expected to be approved Oct. 12 after some final tinkering by the commissioners, will be lower basic phone rates next year. Another will be freedom for the companies to shoot for higher profits and to enjoy unprecedented, if limited, latitude in setting prices for optional telephone services.
The long-term payoff, if the system works as Ford conceived it, will be a streamlined regulatory process that liberates the phone companies to pursue technological advances that benefit the economy and hold down prices for phone customers.
And although many consumer advocates are doubtful that those goals will be realized, the PUC’s push in telecommunications is expected to foreshadow a fundamental change in the way that the agency deals with energy utilities, freight haulers and the other businesses that it regulates.
“There has to be streamlined processing,” said Commissioner John B. Ohanian. “I envision the commission getting away from the ‘micromanagement’ of these companies. Instead, let’s modernize the way we regulate and synchronize it with the pace of change in the business world.”
At the top of the PUC’s agenda is phone regulation. A number of other states have similarly re-examined traditional phone regulation but, with the possible exception of Vermont, California is proposing the most comprehensive overhaul.
Simplified Process
With the new plan, gone will be the close surveillance of management decisions made by Pacific Bell and GTE California--a prospect that delights both companies. Traditional rate-making procedures now require the PUC to determine utility costs, a process that requires poring over corporate books and second-guessing management decisions to arrive at the amount of annual revenue that the company will need to break even. The commission then adds to that sum a maximum profit for the companies to shoot for but not exceed and finally sets phone rates accordingly.
The Ford plan would authorize the PUC to continue setting prices for basic telephone service, although it would simplify the way that is done. It also would:
- Cap prices for such optional “enhanced” services as call forwarding and let the companies lower charges if they wish, perhaps to increase sales volume.
- Deregulate prices for the present handful of competitive services, such as yellow pages advertising and, perhaps, maintenance of phone wires in businesses and homes.
- Replace commission-imposed penalties for unnecessary investments and excessive costs with financial incentives to reward efficiency.
To make this more flexible pricing system work with a minimum of state intrusion, Ford created the most elaborate system so far of “checks and balances” designed to protect shareholders and customers alike. Yet, in California as in the other states tinkering with regulatory reform, only the telecommunications investors and the companies involved seem to support the changes.
Many customers--including giant long-distance carriers such as American Telephone & Telegraph and MCI, which depend on local phone companies to complete their calls--worry that loosened regulation will mean service headaches. Ironically, AT&T; recently was granted greater pricing flexibility in its long-distance operations by both state and federal regulators.
For the first year under the new regulatory setup, the PUC will lower phone rates because both Pacific Bell and GTE California have exceeded their currently authorized profit ceilings.
Productivity Factor
After that, and on Jan. 1 of every year from now on, the companies’ anticipated revenue figure will be adjusted for inflation, minus an assumed reduction in operating costs due to belt-tightening and labor-saving technology.
Ford proposed what it calls a 4% “productivity factor.” Thus, if inflation boosted costs generally by 5%, only a 1% increase would be passed on to telephone customers. “This productivity target will challenge (the phone companies) to be at least 4% more efficient in their operations than is the economy as a whole,” she maintained.
A key question that the five commissioners must decide Oct. 12 is whether Ford’s 4% productivity factor is reasonable. The companies argue that 4% is too ambitious, while the consumer lobby known as TURN (for Toward Utility Rate Normalization) says it should be more like 7%. Moreover, TURN considers Ford’s proposal to be “overwhelmingly skewed in the utilities’ favor,” said executive director Audrie Krause, a former Fresno Bee newspaper reporter who assumed her TURN job last summer.
Under traditional regulation, Krause pointed out, the PUC limited company profits, or rate of return, and required any excess earnings to be refunded. The maximum profit margin for Pacific Bell currently is 11.34% and 11.13% for GTE California.
Because a basic principle of Ford’s plan is to strengthen the profit motive, she set a target rate of return, based on her estimate of current market conditions, of 11.75% for 1990. But she would let the companies keep all earnings up to 12.75% to motivate them to perform well, then would allow them to keep half of any additional earnings up to a maximum of 16.75%.
TURN considers each of these benchmarks, especially the 16.75% maximum return, to be far too generous, and it also urged that if the commission allows any profit sharing, consumers should get 60% of the earnings involved, not 50% as Ford suggested.
In contrast to TURN’s strong opposition, PUC President G. Mitchell Wilk, who has worked closely with Ford as the commissioner responsible for the case, hailed Ford’s framework as “a win-win situation” for customers and investors.
Rewards Efficiency
“It needs to be improved in some areas, filling in some gaps and doing more balancing,” Wilk said, but he defended the 4% productivity factor as “a real stretch” for Pacific Bell and GTE California. He termed TURN’s opposition short-sighted, saying the 1984 breakup of the Bell System and rapid technological changes have made reform inevitable and probably overdue.
“Divestiture changed the regulatory framework for this industry,” Wilk said. “We can’t put our head in the sand and pretend we’re dealing with Ma Bell.”
Carl Danner, Wilk’s telecommunications adviser, said Ford’s framework creates necessary new incentives to reward efficiency and get telephone employees “thinking the way we want them to think” instead of trying to “put one over” on regulators by padding costs to boost revenue.
“Our economy runs on these incentives,” said Danner, who holds a doctorate in public policy from Harvard University’s Kennedy School of Government. “To the degree that the phone companies are losing their monopoly status, their world should begin to look more like that (of the competitive economy). It’s becoming untenable to do the other form of regulation.”
Terry L. Moore, who heads a PUC division representing utility customers, agreed with TURN, however, that some of Ford’s profit targets are too generous and that the productivity factor is too low. Still, Moore added that she is “in general comfortable with the framework” that Ford devised. “The key is getting (rates) right at the start.”
William R. Ahern, a former RAND Corp. analyst who now is PUC director of strategic planning, said Ford’s framework also makes it far more difficult for the phone companies to unfairly subsidize their competitive ventures with profits from the basic phone business. If successful on that score, Ford’s plan would resolve a lot of complaints already made by would-be competitors in such areas as voice-mail services, privately owned pay phones and telephone wiring repairs.
Complex Case
Commissioner Frederick R. Duda called the impending commission decision “clearly historical” and one not to be confused with deregulation. “This is not deregulation and it’s not traditional regulation,” he said. “It’s a compromise. And the question is whether it will work and for how long.
“Marketplace reality has caught up with the system,” Duda said.
Duda--along with Commissioners Ohanian, Wilk, Stanley W. Hulett and Patricia M. Eckert--has reservations on a number of details, but all five seemed, in separate interviews last month, to be generally pleased with the comprehensive plan.
For Ford, the telephone case represents by far the most complex that she has handled. The Mississippi native, who holds a bachelor’s degree in mathematics and a master’s in electrical engineering, said her aim was to devise a framework that would work adequately even when some of the forecasts for the telephone business are off the mark.
“We can be fooled by forecasts,” Ford said recently as she sat in her tiny office surrounded by volumes of hearing testimony and a stack of comments on her framework. She said she tried to create “checks and balances” within the framework to contain excessive earnings--or losses if the bottom falls out of the market--within reasonable limits.
That approach is also demonstrated, she said, by the way in which implementation will give customers the first benefit in the form of an immediate rate cut, in inflation-adjusted dollars, while shareholders will get theirs later in the form of higher profits if their company performs well.
In any case, she added, the commission will reassess the new system in 1992.
Some Doubters
Investment analysts generally warm to any attempt to allow market forces to work within a regulated environment--and especially to shift from cost-based regulation to pricing regulation because of the potential for higher earnings. Even so, Robert B. Morris III of Goldman, Sachs & Co. foresees some potential problems for both telephone customers and the companies themselves.
“It’s a break from historical regulation,” Morris acknowledged, “but to me it doesn’t appear that the commission has handed them the keys to the kingdom.”
Moreover, he added, there may be a drawback for consumers. By dividing telephone offerings between tightly regulated basic telephone service and flexibly priced enhanced telecommunications services, Morris said, the new regulatory framework may interfere with the smooth flow of new technology throughout California.
In other words, Morris said, some markets outside major metropolitan areas might not get certain advanced services unless regulators require them to. “Only markets that can pay for them will get the services,” Morris predicted.
To Ford, criticism and controversy come with the territory. “No one’s going to entirely like what you do,” she said.
“And if someone does,” she added, “it makes you wonder if you’ve done the job.”
