Date: Wed, 20 Nov 1996 22:34:46 -0800 From: Richard Kashdan Subject: PUC's Proposed Decision in California ISDN case Administrative Law Judge Kim Malcolm of the California Public Utilities Commission released her Proposed Decision yesterday regarding Pacific Bell's application to raise ISDN rates. This is not the final order of the Commission, but rather a rough draft for the parties to comment on and try to change her mind. The parties have 20 days to submit comments and then an additional 5 days to submit replies to the comments of the other parties. After reading the comments, the ALJ may amend the proposed decision and then she submits it to the Commissioners for approval. It might get approved as-is or revised by the Commissioners, and the final decision could take months. I scanned and OCR'ed a copy that I picked up yesterday hot off the press. I proofread this a little bit and fixed the really obvious errors, but be warned that there are probably still a lot of scanning errors mixed in. Pacific Bell asked for an increase of $8.00 per month per BRI line. The proposed decision does not set a new rate yet. It asks the company to modify its cost studies "slightly" in specific ways and re-submit them, and then a monthly rate will be set. I suspect that the modifications, after scrutiny by the parties, will lead to a reduction from the $8.00 that is far more than "slight." Currently California Pacific Bell residential ISDN customers get unlimited usage on evenings and weekends. Pacific Bell asked to limit this to free usage for only the first 20 hours and then per-minute charges after that. The proposed decision gives 200 free hours instead. Pacific Bell tried to sneak in limitations on most ISDN features so that they would be available to business customers only. The proposed decision allows residential customers to purchase the same features as business customers and at the same rates. The proposed decision orders specific timelines for installation and repair of ISDN lines with monetary penalties to the customer if these are not met. The proposed decision orders Pacific Bell to make ISDN available to resellers with a 17% discount. The installation charge for the ISDN feature will continue to be $125, but residential customers will be allowed to pay this in 6 monthly installments. This $125 is for the conversion of an existing line to ISDN. If the customer orders a brand new ISDN line the installation fee is $34.75 for the line plus $125 for ISDN. Pacific Bell used to waive the $125 if the customer kept the line for 2 years, but that waiver was for 2 years only and expired several months ago, independently of this case. Pacific Bell currently charges $4.00 extra per month for a package of ISDN voice features including Hold, Consultation Hold, Three-way Conferencing, and Call Transfer. These would be free under the new rates. There will also be small discounts for customers who order large numbers of ISDN lines and keep them for long periods of time. ================================================================= Proposed Decision of ALJ Malcolm (Mailed 11/19/96) Application 95-12-043 Case 96-02-002 This decision resolves the application of Pacific Bell (Pacific) for approval of rate increases to its Integrated Services' Digital Network (ISDN) services. It also resolves the complaint of Compaq Computer Corporation and Intel Corporation (Compaq/Intel) against Pacific which alleges that Pacific provides inadequate ISDN service. In summary, we order Pacific to modify slightly its cost studies and make corresponding changes to its ISDN rates. We direct Pacific to implement performance incentives for improving its customer services and to submit customer survey results for our review over the next two years. I. Introduction &. Procedural Background On February 19, 1993, the Commission approved a request by Pacific for authority to offer ISDN business of a provisional tariff. (Resolution T-15246.) authorizing the tariffs also ordered Pacific to letter for provisional residential ISDN service 1993. The Commission subsequently approved the tariff in May, 1994. Pacific filed this application on December 5, 1995, seeking permanent status of its ISDN services and to restructure and raise the rates of ISDN services. Subsequently, Pacific filed an amendment to its application to eliminate its initial proposal to increase usage rates. Its amendment proposes instead to increase monthly charges by $8.00 per month. Pacific states it modified its application pursuant to Decision 96-03-020, which changed ISDN from a Category I service to a Category II service, among other things. Compaq/Intel filed this complaint on February 1, 1996, alleging unreasonable rates, inadequate service, and unreasonable marketing practices. The Commission consolidated these proceedings because of the related nature of the issues. At the suggestion of the assigned Administrative Law Judge (ALJ) and the assigned Commissioner, several parties subsequently met to discuss settling matters of controversy. On July 17, 1996, Pacific filed a motion to adopt a settlement signed by Pacific, California Cable Television Association (CCTA), California ISDN Users' Group (ISDN Users), Jetstream Communications Inc. (Jetstream), Siemens Rolm Communications, Inc. (Siemons Rolm), and Flow Point Corporation. At a prehearing conference on July 29, 1996, bye settling parties proposed to postpone the hearings in order for the Commission to consider the settlement before hearing the evidence presented by other parties. The assigned ALJ declined to postpone scheduled hearings on the application and complaint following consultation with the assigned Commissioner on the basis that several parties protested the settlement and the settlement improperly sought to resolve issues raised by the complaint without the signatures of the complainants. At the same time, the assigned ALJ also determined that the complaint did not conform to the requirements of Section 1702 with regard to its allegations of unreasonable rates. Specifically, the complaint is not filed by "the mayor or the president or chairman of the board of trustees or a majority of the council, Commission, or other legislative body of the city or city and county within which the alleged violation occurred, or by not less than 25 actual or prospective consumers or purchasers" of the utility's service. Because the complainants do not have standing to allege that Pacific's rates are unreasonable under Section 1702, the ALJ stated the Commission would hear only those issues in the complaint relating to service quality and marketing practices. She appropriately found that the complainants would not be prejudiced in any way because they could raise issues regarding the reasonableness of ISDN rates in the consolidated application. Elements of the complaint regarding service quality are nevertheless considered here. The Commission held hearings in the consolidated proceedings during the weeks of July 29 and August 5, 1996. Pacific, Compaq/Intel, Utility Consumers Action Network (UCAN), Dirk Hughes-Hartogs (Hughes-Hartogs), Jetstream, CCTA, the Commission's Office of Ratepayer Advocates (ORA)1, Toward Utility Rate Normalization (TURN) Thomas McWilliams, and ISDN Users were all active in the proceeding, either presenting witnesses, or cross-examining witnesses or filing briefs or some combination.2 Pacific's provisional tariffs expired on August 2, 1996. On the same day, the Commission issued Resolution T-15948, which extended the provisional tariffs until such time as the rate and service issues were resolved in this application. 1 By action of the Executive Director, the Division of Ratepayer Advocates ceased to exist as a staff unit on September 10, 1996. The functions it performed as a participant in this proceeding now reside with the Commission's Office of Ratepayer Advocates. 2 Although the record in this proceeding is extensive, Pacific chose not to brief many of the issues, submitting an opening brief of less than 20 pages. Pacific's reply brief was similarly terse. Therefore, this decision seeks to represent Pacific's assessments of the record evidence on various and complex issues with little assistance from the applicant. B. ISDN Services and Their Applications ISDN services have been available since 1989 although the technology is only recently a highly marketable product. Initially, the applications for ISDN were limited. Pacific offered ISDN to Centrex customers to enable large businesses to add multiple ISDN phone sets to a single Centrex line for voice transmissions. Without this enhancement, only one phone could be attached to a single line. ISDN is currently used to boost the capabilities of existing copper connections between a customer's premises and the utility's switching facilities. ISDN accomplishes this improved connection by employing channels which are equivalent to two "plain old telephone service" (POTS) channels and one "D" channel which can be used for signaling. ISDN thereby provides data transfer rates of up to 128 kilobits per second (kbps), a rate about four times faster than using analog POTS with a fast modem. In addition to improving transmission speed, ISDN improves reliability. Importantly, ISDN permits up to eight items of customer equipment to be connected to a single line. These connections are digital rather than analog, which is the technology of the existing POTS plant. Since 1993, ISDN has had potential applications which may serve a large group of customers. It is now most commonly used to increase the speed of data transmission between computers. For example, ISDN is used by telecommuters to increase the speed of data transmission to and from local area networks (LAN) at their places of business. It is used by customers who seek improved connections to the Internet. According to some intervenors, some customers use ISDN for their telephone service to improve connection quality. C. Pacific's Application Pacific's existing ISDN rates are as follows: Usage Monthly Charge Business $.0105 $25.75 Residential/"Home" $.0105 $24.50 Pacific proposes in its amended application to increase monthly recurring charges of Business, Home and Centrex ISDN by $8. Pacific does not propose changes in usage rates, although it would eliminate the existing unlimited free usage offered to Home ISDN customers during off-peak periods. The application proposes a 20-hour cap on off-peak local usage for Home ISDN. It would also eliminate the $4 existing charge for certain optional features: Hold, Consultation Hold, Three-way Conferencing, and Call Transfer. Under Pacific's proposal, these optional features would be bundled with the basic product. The application would offer volume and term discounts of up to $4 on the monthly recurring charge and offer a discount plan for intraLATA toll services to ISDN customers. Pacific proposes to retain the existing installation charge of $125 for business and residential customers. Until August 2, 1996, Pacific waived the installation charge for residential customers as part of an introductory offering. Several parties protested Pacific's application: Compaq/Intel, TURN, MCI Telecommunications Corporation, Hughes--Hartogs, UCAN, and AT&T Communications of California, Inc. In general, the protests argued that Pacific's proposed rates would be unreasonably high. The Commission also received about 1200 informal protests, mostly over electronic mail, from ISDN customers or prospective customers who opposed the rate increase. D. Compaq/Intel's Complaint Compaq/Intel filed this complaint alleging, among other things, that Pacific has provided inadequate service because its service representatives were hard to reach and poorly trained. It further alleges that customers requesting ISDN services are subjected to unreasonable delays and that Pacific has generally deterred customer demand for ISDN services. The complaint also alleges that Pacific markets almost exclusively under its Business tariff and does not provide an equivalent service to residential ISDN users. Pacific answered the complaint, denying all allegations with regard to poor service or discriminatory practices toward or against any class of customer. II. Regulatory Environment The parties identified other regulatory forums which might in some fashion affect the way the Commission addresses issues raised in these consolidated proceedings. A. ISDN Rates Under New Regulatory Framework (NRF) Pacific is subject to ratemaking principles established under the new regulation network (NRF), adopted in D.89-10-031. NRF imposes a freeze on the prices of Pacific services which are monopolistic or offered in markets which are not fully competitive. However, we provided for exceptions to the freeze. We recently issued D.95-12-052 which clarifies that exemptions from the price freezes will be authorized for "Commission -approved rate increases above the price caps." Originally, ISDN was a Category I service, that is, we considered it a monopoly product with no close substitutes. We recently changed the status of ISDN services from Category I service to Category II service in D.96-03-020. Category II services are those for which competition has been authorized but where the utility retains considerable market power. We have also identified discretionary services as Category II services. For Category II services, we have normally permitted pricing flexibility between rate ceilings and rate floors which are set at direct embedded costs or long-run incremental costs. Increases to Category II services must receive formal Commission approval. The wisdom of a price increase for a Category II service depends largely upon whether the service is recovering costs. Our policy is generally designed to promote efficient operations by way of cost reductions wherever they may be achieved without compromising high quality service. The parties do not agree about whether Commission policy in this area entitles Pacific to price increases for ISDN services. Compaq/Intel argue that Commission policy does not permit a rate increase in this case because Pacific's records suggest that ISDN will be profitable under existing rates by the year 2000 through cost-cutting. UCAN argues that the Commission must consider the lack of competition for ISDN services in determining the reasonableness of a rate increase, consistent with D.89-10-031 and subsequent decisions addressing NRF provisions. Generally, the regulatory program under NFR does not permit Pacific to seek rate increases for individual services (except where pricing flexibility is approved and exercised) for the simple reason that we do not review its operations to determine where rate decreases may be warranted. In this case, however, we are approving the adoption of a permanent tariff after a period during which Pacific was able to track relevant information associated with a new service. A thorough review of its costs and associated rates is therefore appropriate. We agree however that if ISDN services would be profitable without a rate increase, and they are not clearly part of a competitive market, Pacific would likely be unable to justify a rate increase. These, of course, are matters of controversy in this proceeding and are addressed in turn in subsequent sections of this decision. B. Relationship to Open Access Network Architecture Development (OANAD) Proceeding The Commission's OANAD proceeding was established to review the costs of "basic network functions" which would underlie the prices for wholesale service offerings by local exchange companies (LEC). The parties to this proceeding disputed the relationship of this proceeding to OANAD. At the time of briefing, ORA filed a motion to suspend the proceeding in order to review the effects of OANAD principles set forth in D.96-08-021 and similar issues raised in Federal Communications Commission (FCC) dockets. (CC Docket Nos. 96-08 and 95-185, FCC 96-325). Pacific and Compaq/Intel opposed the motion largely on the basis that the relevant orders of the FCC and the Commission in OANAD sought to resolve wholesale rates rather than retail rates as this proceeding would. The assigned ALJ denied ORA's motion, concurring with Pacific and Compaq/Intel's observations regarding the scope of the OANAD proceeding and the FCC's orders. As the assigned ALJ stated, the Commission may modify retail rates set here if wholesale rates set for ISDN basic network functions are ultimately inconsistent. That is, wholesale components of ISDN which are priced too close to the retail rate or are set higher than the retail rate would suggest that the retail rate is priced below cost, impeding efficiency, and dampening competition in ISDN markets. In that case, we would revisit the rates set here. We do not anticipate the development of wholesale rates for ISDN basic network functions in the immediate future and, therefore, proceed to address the retail rates in this proceeding. Our resolution of ORA's motion indirectly addresses the proposal of CCTA to set rates in this proceeding on an interim basis. CCTA recommended that the rates set here be interim for reasons similar to those presented by ORA in proposing to suspend the proceeding, that is, so that the Commission may consider the effects of cost studies being developed in OANAD and in light of FCC orders. As we imply above, the rates established here will be interim to the extent they may be changed at some future time to accommodate decisions in other forums. We invite CCTA or any other party to file a petition to modify this decision if it believes the rates we set today are ultimately inconsistent with OANAD or FCC orders addressing wholesale rate elements for ISDN services. III. Market Environment A. Commission Policy Regarding Technology Deployment By now, it hardly bears repeating that the Commission's policy is to promote competition in utility markets. We have adopted this policy assuming that competition will promote the most efficient provision of products and services and will provide incentives for technological development. As a regulatory objective, technological development is particularly germane in light of the continuing explosion of improved applications of computer and telecommunications offerings and the concurrent commitment of Congress to lay the foundations for further exploitation of market resources in this area. In their brief, Compaq/Intel observe that n the PC (personal computer) has become a key form of CPE (customer premises equipment, that is, telecommunications equipment for the home or workplace). N ISDN appears to play an important role in the widespread deployment of computer and telecommunications applications at this time, especially because of its capability to increase the speed and quality of computer connections to remote locations. Compaq/Intel argue that Pacific and other LECs have failed to promote or, in some cases, permit innovation in their markets. With regard to ISDN, Compaq/Intel believe that Pacific, as the only provider of the underlying service, will hamper the deployment of services which complement computer and data services and products. Pacific states that it shares the Commission's policy to promote technological innovation. It argues, however, that the Commission cannot expect an LEC to develop and deploy new technology if it is not permitted to recover its costs and a reasonable return on investment. We consider Pacific's rate request in light of our policy to promote development and deployment of improved telecommunications products and services. Specifically, we recognize that a product that is priced below cost will hamper the development of efficient market alternatives. Conversely, a product that is priced above cost will promote the development of alternatives that are not efficient and will dampen demand for the overpriced service. We seek to avoid either of these circumstances. We also reconfirm our support for products, such as ISDN, which improve access to evolving information services and, in fact, make that access possible for some who would otherwise be unable to afford it. B. ISDN Alternatives Whether ISDN services are competitive depends largely on whether there exist alternative products or services or other providers of this service. The parties debated this matter at some length. Pacific argues that ISDN is not the only means by which customers can send and transmit data. It observes that plain telephone service will transmit the same data transmitted by ISDN, although at a much slower rate. It believes that T-1 and frame relay services offer comparable capabilities. It argues that ISDN is neither necessary nor essential. CCTA comments that the question of ISDN's competitiveness should not be at issue in this proceeding because, in classifying ISDN as a Category II service, the Commission has already laid the matter to rest. UCAN argues that the testimony demonstrates no technology exists which provides comparable benefits to ISDN at a comparable cost. It observes that several emerging technologies share some of the attributes of ISDN, but none are widely available or affordable and that T-1 services are too expensive for all but the largest users. UCAN believes that Pacific's view that cable modems are an alternative to ISDN is contradicted by its own studies, which show the cable industry's distribution plant is not digital, a requirement for a product to be comparable to ISDN. As evidence that competition does not exist for ISDN services, Compaq/Intel argue that a company will not increase its prices when it anticipates competition. It observes that Pacific will not face any competition for ISDN services because ISDN works on copper wires and competitors will not invest in redundant plant to provide ISDN independently. The evidence in this proceeding does not demonstrate the availability of a product which is comparable to ISDN or that competitors offer ISDN. Cable modems are not commercially available at this time and appear unlikely to be available in most markets in the near future. Technologies such as T-1 are economic only for large users. The record supports Compaq/Intel's position that computer modems, which increase data delivery speeds, cannot be substantially improved upon. Analog modems combined with POTS are alternatives to ISDN to the extent they provide a connection for data transmission; they are not realistic alternatives, however, from the standpoint of speed and reliability. ISDN appears to be the only economical product available to small business and residential customers which offers truly high speed transmission. At this time, LECs are the only facilities-based providers of ISDN service. The record does not suggest that competitors will ever offer ISDN service except by reselling the local exchange companies' services. C. Effects of Service and Pricing on ISDN Deployment In discussing the benefits of more efficient provision of utility products, D.89-10-031 stated that "The goal of full network utilization has two components: (1) retaining and expanding the customer base for existing services and (2) adding new services. Higher levels of network utilization lower average costs and can mean avoidance of duplicative investment." Pacific adds that pricing services below cost will discourage new entry. It believes that its prices must exceed cost to encourage market entry and assure high quality service, commenting that the latter will speed deployment. Compaq/Intel argue that Pacific has a potential customer base for ISDN services which it has failed to develop. It observes that Pacific has over 15 million POTS lines, 9 million of which serve residential customers. Yet it has installed fewer than 8,000 lines for residential customers and only 60,000 business customers. Compaq/Intel refer to Pacific's own projections during 1995 that it would have a million ISDN users by the end of 1997. Compaq/Intel also observe that Pacific's estimates of demand elasticity suggest that the rate increases Pacific proposes would reduce demand by about 25%. According to Compaq/Intel, the effects of the rate increase combined with poor marketing and customer service will continue to retard the use of ISDN services. Existing Commission policy provides that prices for competitive products and products that are potentially competitive should be based on costs, using the TSLRIC methodology. The alternative to a cost-based pricing regime for ISDN would be for Pacific to realize extraordinary profits from ISDN or to subsidize it with the revenues from other services. Neither of these alternatives is palatable in the context of our objectives to promote efficient markets and the development of competitive products and services. In this case, Pacific has the burden to demonstrate that its costs support a rate increase, especially where Pacific's product faces little or no competition and where we have stated our intent to promote deployment of information technologies. Ultimately, our goal is to get out of the business of pricing services such as ISDN. When competition is assured, ISDN providers will not be able to price ISDN services higher than levels which would permit them to recover costs and a reasonable profit. Until then, we will oversee Pacific's ISDN prices. IV. Costing For I8DN Services A. The Appropriate Costing Model The parties agree that the TSLRIC principles identified in the OANAD proceeding must be applied here for ISDN ( See D. 96-08-021). Pacific presented a cost study based on TSLRIC; it argues that this cost study has already been approved by the Commission in the OANAD proceeding. Compaq/Intel and ORA dispute that assertion. We agree with Compaq/Intel and ORA that the Commission has not resolved ISDN cost issues in the depth required to adopt a final cost estimate upon which to base retail prices. The application of the TSLRIC model, and the inputs to it remain unresolved and are, in fact, the subjects of considerable dispute here. We address these disputes below. B. The Application of the Cost Model Pacific states its use of the TSLRIC model in this proceeding is consistent with the cost principles adopted in D. 95-12-016. Its witness stated that using the Commission's costing principles, ISDN is currently priced below cost. Pacific originally justified its rate increase request on the basis that two of its original cost assumptions have turned out to be faulty. One of those assumptions concerns the distance of customers from their central offices and the other concerns the amount of time residential ISDN customers have spent using the service during off-peak hours when usage is free. We address each of these in turn and then other costing issues raised by intervenors. 1. Customer Distance From Central Offices Pacific's application justifies its proposed rate increase on the basis that two of the assumptions in its original ISDN tariff filing have proved inaccurate. The application describes one of those inaccurate assumptions to the effect that "Our original studies estimated 12% of the customers would be located more than 15 kilofeet from the central office. These studies reflected that many of the earlier ISDN customers were centered closer to wire centers in more metropolitan areas. Our current studies - which are based on actual use - indicate that 24% of Business ISDN and 30% of Home (residential) ISDN customers are located more than 15 kilofeet from the central office." Pacific subsequently amended its cost study to reflect its view that special equipment was required where customers were more than 13.8 kilofeet from the central office. Hughes-Hartogs argues that Pacific has failed to demonstrate this essential premise of its request for a rate increase, namely, that more customers than originally estimated require "repeaters on their lines before ISDN can be installed. Pacific responds that its cost study does not presume the need for any repeaters but rather presumes the installation of digital loop carriers which obviate the need for repeaters. It states that it undertakes certain line conditioning for customers who are more than 13.8 kilofeet from their central offices. It asserts it has incorporated associated cost savings in its cost study. In response to data requests, however, Pacific states that the numbers of repeaters installed on business and residential lines are very close to Pacific's original assumptions, 12% and 14%, respectively. It also continues to argue the need for repeaters in response to intervenors' criticisms in this area. We cannot tell from the record why Pacific refers to repeaters as if they are no longer a useful technology. Nor can we understand why Pacific assumes improvements are required for a larger share of customers than have previously required improvements (that is, repeaters). We cannot determine how Pacific's cost studies incorporate the cost of repeaters, if at all, and, if they do not, why Pacific continues to defend their installation. Moreover, the record does not support Pacific's assumption that the number of customers located more than 13.8 kilofeet from their central offices has changed. Because Pacific has the burden to show the reasonableness of its cost study, we agree with UCAN and Hughes-Hartogs that the cost study should be amended to reflect the estimates of customers which are more than 13.8 kilofeet from their central offices consistent with Pacific's data on ISDN customer equipment installations so far. Thus, Pacific should modify its cost study to reflect assumptions that 12% of business customers and 14% of residential customers are located more than 13.8 kilofeet from their central offices. 2. Off-peak Use by Residential Customer" Pacific's application states it requires a rate increase in part to reflect off-peak use by residential customers which exceeds the levels it estimated in its original tariff filing. It proposes to provide free off-peak usage up to 20 hours a month, which, Pacific believes, accommodates the usage patterns of most residential ISDN customers. Pacific provided a sample of residential customer bills which suggested that off-peak usage has been higher than the original estimate of 15 hours per month, now estimating average usage to be closer to 47 hours a month. UCAN and Compaq/Intel argue that Pacific's estimates of average usage are flawed because Pacific did not use a random sample or a large enough sample. They also argue that Pacific's calculation of usage from the sample was faulty. Hughes-Hartogs disputes Pacific's statement that it previously assumed residential usage would be about 15 hours per month. In making this point, Hughes-Hartogs refers to a letter from a Pacific attorney to a Commission manager dated December 14, 1993 which stated that 45 hours of residential usage in the evening hours was "in line with anticipated residential customer calling patterns." Hughes-Hartogs also argues that whether the residential off-peak usage is actually 15 hours or 47 hours should not matter. Forty-seven hours of off-peak usage equals only about 45 minutes per day per channel, not an amount that is unusually high and is one that is used by less than 5% of ISDN customers. Such a level would not increase ISDN costs according to Hughes--Hartogs. Hughes-Hartogs observes that Pacific's witness testified that congestion from high usage is remedied by redistributing lines in the central office, a remedy which Hughes-Hartogs believes costs "nothing but one-time labor." Similarly, UCAN argues that Pacific has failed to establish that off-peak usage by residential customers causes any loss of revenue or imposes additional cost on Pacific. It observes that congestion from off-peak usage of ISDN is unlikely considering that POTS usage presents the same problem. UCAN points out that there are 9 million residential POTS lines in California compared to less than 9,000 residential ISDN lines. Thus, according to UCAN, to the extent congestion occurs, the majority is surely the result of POTS calls. We cannot tell from Pacific's testimony or brief how monthly residential ISDN usage exceeding 20 hours during off-peak periods imposes costs on its system which should be recovered from usage rates. Its witness referred to central office modifications required to relieve congestion but did not establish that such modifications were required if ISDN customers were to use more than 20 hours of service a month during off-peak periods. Pacific did not clarify how ISDN customers could be the source of congestion in light of the fact that ISDN customers represent a tiny fraction of customers using central office equipment and that off-peak periods are, by definition, those during which plenty of capacity is unused. In fact, Pacific's internet offering actually promotes off-peak use by providing free usage during those periods. Its witness in A.96-04-038 testified that stresses on its system during off-peak hours were attributable to all internet users, not just those using ISDN service. It is unclear how Pacific's cost study incorporates capital costs associated with congestion, if at all. Pacific appears to propose to make up what it believes are system costs by way of usage rates. If that is correct, we would implicitly address costing issues in this circumstance by adjusting rate design. We address the rate design impacts of this issue below. 3. Forward-Looking Cost Estimates ORA, UCAN and Compaq/Intel believe that Pacific's TSLRIC analysis fails to comply with the "Consensus Costing Principles" the Commission adopted for TSLRIC cost studies. Specifically, they argue that Pacific has not adjusted its cost estimates so that they reflect the period during which the proposed rates would be in effect. Compaq/Intel believe Pacific's use of 1994 booked expenses and volumes for estimating secondary capital costs and cash operating expenses is faulty. UCAN and Compaq/Intel argue that because Pacific uses obsolete data, its analysis fails to capture economies of scope and scale from widespread use of ISDN and also fails to incorporate cost reductions from marketing and operating improvements. They argue additionally that Pacific assumes that past costs will equal future costs. ORA objects specifically to Pacific's use of direct embedded costs in estimating ISDN costs. UCAN and Compaq/Intel assert that evidence of the futility of Pacific's reliance on 1994 data is Pacific's decision to use adjusted data for its sales and advertising expenses. Specifically, Pacific recognized that spreading the relatively high level of costs associated with marketing a new product over the 1994 customer base would present an unrealistic estimate of 1996 costs. UCAN applied 1998 estimated volumes to these costs, substantially reducing per customer costs. In addition, Compaq/Intel believe that Pacific overstated the cost of billing inquiries on the basis that such inquiries may be expected to fall as the product matures. If the model is adjusted to correct for these various problems, according to Compaq/Intel, ISDN costs do not exceed current rates. ORA shares these concerns about the validity of Pacific's TSLRIC cost studies, arguing that they appear inconsistent with the Commission's requirement that cost estimates be "forward-looking." (D. 95-12-016). ORA believes Pacific exaggerates the cost of labor and incorrectly assumes that the per unit cost of ISDN line cards would decline as demand for ISDN grew. Pacific responds that the Commission's costing policies do, in fact, require forward-looking cost estimates but that the Commission has stated its preference for using actual costs wherever possible. We agree with UCAN, ORA and Compaq/Intel that Pacific's cost estimates inappropriately assume 1994 costs. Those costs are now nearly three years old and ISDN is no longer a "start up" product with attendant high marketing and sales costs. As Hughes-Hartogs observes, even Pacific implicitly admits the fallacy of using 1994 data when it states that the purpose of the provisional tariffs was "to gain experience with a service to use as the basis for setting rates in the permanent tariff." Most of the experience Pacific has gained with ISDN occurred during 1995 and 1996, not 1994. In this case, much has or is likely to change between 1994 and 1997 in Pacific's ISDN markets. In 1994, Pacific had less than 30,000 ISDN customers. It estimates it will have 400,000 ISDN customers in 1997. These additional subscribers will make a substantial impact on per unit costs, that is, those that do not vary according to volumes. Pacific is correct that we prefer actual costs where they are available, but we would use past costs as a foundation for future costs, with appropriate adjustments to reflect anticipated volumes and costs. Pacific did not consistently make such adjustments in this case. We will direct Pacific to modify its cost study by using 1996 estimates for costs that are not volume sensitive. Costs should be extrapolated from actual data available for the first eight months of 1996 for costs associated with billing inquiries, general purpose computer expenses, and official company services (OCS). Pacific should also incorporate into the model the volumes it anticipates for 1997 of approximately 400,000 ISDN customers. 4. Inclusion of POTS Costs in ISDN Estimate Hughes-Hartogs believes Pacific inappropriately included certain costs associated with POTS in its ISDN estimate. It recommends removing the costs of DAML, load coils, ring generators, DTMF recognizers, and dialtone generators. These features, according to Hughes-Hartogs, are not used by ISDN customers and should, therefore, not be charged to ISDN rates. Pacific did not address this issue. Because it has the burden to demonstrate the reasonableness of its rate increase request, and Hughes-Hartogs' concern is intuitively sound, we will direct Pacific to modify its cost study accordingly. V. Pricing ISDN Services A. ISDN Rates and Rate Design Pacific argues that its rates are below cost and, therefore, subsidized. It observes that underpriced services will dampen the development of competitive options and artificially increase demand for the service. Pacific believes its rate design will maintain the affordable quality of ISDN service. UCAN argues Pacific should not be permitted to increase ISDN rates for several reasons. It believes a rate increase will dampen usage, eliminate rate stability for customers who have made large investments in related equipment, and would unreasonably increase Pacific's profits. As a matter of policy, UCAN believes Pacific should not be granted a rate increase while it is providing a substandard customer service and technical support. UCAN, Hughes-Hartogs, and Compaq/Intel suggest that Pacific should offer a flat rate ISDN service in order to encourage its use. They argue against the 20-hour cap on off- peak residential usage on the basis that congestion only occurs when usage exceeds 200 hours a month, according to Pacific's witness, usage which is attributable to only 3% of ISDN customers. With this in mind, UCAN argues, Pacific would penalize the 22% of ISDN customers who use the system more than 20 hours a month but less than 200 hours a month. ORA believes Pacific will eventually have to establish pricing flexibility because ISDN services are classified as Category II services. Pricing flexibility in this context means the establishment of a price floor and a price ceiling. Generally, ORA recommends denying any of Pacific's request for prices changes on the basis that Pacific has failed to satisfy its burden of proof. ISDN Users Group recommends that Pacific should offer 200 hours of monthly free off-peak usage rather than 20, as Pacific proposes. Jetstream observes that customers would prefer lower prices although it believes there is no evidence to suggest that the market sensitivity to ISDN prices is "more than minimal." Jetstream adds that product availability and good service are perhaps more critical in deploying ISDN. Jetstream also observes that requiring Pacific to provide large amounts of free network usage will require adjustments to the cost model and, presumably increases to the monthly charges. In general, we have already stated our intent to set ISDN rates at cost, consistent with existing policy. In the context of this objective, we do not need to address in any detail whether Pacific will reap extraordinary profits or whether a rate increase will unreasonably dampen demand. Pacific cannot make extraordinary profits to the extent its rates approximate costs. Setting rates at costs will signal competitors as to the economic value of alternatives and promote demand for ISDN which corresponds to the value of the product in the economy. In subsequent sections of this order, we address whether Pacific~s ISDN customer service is adequate and the extent to which the guality of its customer service should affect rates or profits, if at all. We have already discussed our view that Pacific failed to demonstrate that off-peak residential usage was creating congestion that would impose system costs. We accept its concern that excessive use off-peak by a far larger number of ISDN customers will contribute to system costs to some extent if, for example, Pacific must redistribute lines in its central offices. We are also aware that unlimited usage provisions will fail to encourage customers to disconnect their systems when they are not using them. In the longer term, failing to provide an incentive to customers to disconnect from the system when they are not using it could ultimately create system congestion as thousands more ISDN customers subscribe to the service. Pacific's information suggests that only those ISDN customers who use more than 200 hours of off-peak service a month may create system congestion. Customers who use more than 200 hours a month off-peak represent only 3% of Pacific's residential ISDN customers. Logically, those 3% of ISDN customers should pay the associated costs. We will require Pacific to modify its rate proposal to provide 200 free hours of off-peak usage to residential ISDN customers. Customers who use more than 200 hours a month should pay the adopted usage rates for the time they spend on the system over 200 hours. With that change in Pacific's proposed rate design, we will, as Pacific proposes, require Pacific to retain existing levels of usage rates and change monthly charges by amounts which result from changes to the cost studies we addressed in earlier sections. B. Installation Charges Pacific's original tariffs provided for a waiver of the installation charge of $125 for residential customers. That waiver expired on August 2, 1996. UCAN and Hughes-Hartogs recommend that Pacific continue to waive the $125 installation fee for customers who agree to a two-year term agreement in order to maximize subscription levels. Installation fees in any event should be payable over a six-month period according to Hughes-Hartogs, ISDN Users Group and UCAN. Pacific proposes to eliminate the waiver of the installation fee to residential customers. It does not object to allowing residential customers to pay the fee over time. We agree that the installation charge is reasonable and, with Pacific's concurrence, direct Pacific to modify its tariffs to permit customers to pay the installation charge over six months beginning with the first ISDN billing period. C Pricing Flexibility Because ISDN is a Category II service, Pacific is permitted to reduce but not increase ISDN prices without formal Commission approval. ORA believes Pacific was required to propose pricing "floors" in this proceeding. D.89-10-031 requires a utility to "request that flexible pricing be implemented and floors established" when it "files an application requesting recategorization of a service into Category II." In this instance, Pacific did not request that we recategorize ISDN services. If Pacific seeks to implement flexible pricing for ISDN services, it must file an application. Pacific states here that its proposed prices are already at the level of the pricing floor, that is, TSLRIC. In order to implement flexible pricing, Pacific would have to seek another rate increase from which it could reduce its rates. We do not intend to process another rate case for ISDN in the near future. D. Wholesale Prices This Commission and the FCC have stated their common objective to require LECs to establish wholesale prices for their services and to offer them to companies who would resell them. In D. 96-03-020, we found that wholesale rates for Pacific's ISDN services should be established pursuant to our findings in this proceeding. D. 96-03-020 found generally that wholesale rates should be set at a discount of 17% from retail rates. Since we issued D. 96-03-020, the status of that order has been unclear as a result of an FCC order adopting interconnection rules. We are investigating this matter in our consolidated proceedings, Rulemaking 95-04-043 and Investigation 95-04-044, where we are considering local competition. In the meantime, we will order Pacific to offer a wholesale rate at a discount of 17% from the retail rates set here, subject to change according to final Commission and FCC requirements. E. Special ISDN Features Pacific's proposed tariff sheets appear to withdraw special ISDN features for residential users. Pacific did not propose this in its application or justify it in testimony. To the contrary, Pacific's application appears to propose to bundle these services with basic rates. We, therefore, direct Pacific to provide those services to residential customers on the same basis that they will be offered to business customers. F. ISDN Connections for Basic Service Hughes-Hartogs suggested that Pacific be required to offer ISDN service as part of its basic service in order to improve the quality of basic service. We are aware that Pacific could, from an engineering standpoint, provide ISDN as part of its basic service package and that the system modifications would improve the quality of basic service connections. The implications of this proposal, however, are substantial and better considered in the context of our broader review of Universal Service. Offering ISDN as part of basic service would increase the cost of basic service substantially, either requiring increased basic service rates or subsidies from other services. It would also require that basic service customers purchase telephone equipment which is compatible with ISDN connections, an investment which would apparently exceed $100 for each customer. We are not prepared to make these commitments on behalf of ratepayers at this time and with the limited information we have before us. VI. Service Quality and Marketing UCAN and Compaq/Intel argue that Pacific has failed to provide adequate customer service to ISDN customers. Specifically, they allege customers experience poor telephone services, untrained ISDN representatives, delays in hook-ups, and missed appointments. Compaq/Intel believe the evidence demonstrates that Pacific is not meeting the demands of its customers for ISDN. Compaq/Intel and UCAN argue that Pacific has a legal obligation to provide "just and reasonable" service. UCAN and Compaq/Intel argue Pacific should be denied any rate increases until it has demonstrated improvements to its customer service. UCAN compares customer satisfaction with Pacific's ISDN services to customer satisfaction with Pacific's services overall. UCAN observes that 72% of Pacific's ISDN customers are satisfied with ISDN service compared to a substantially higher percentage of positive responses from Pacific customers about overall services. Jetstream comments generally that Pacific's problems with ISDN service are not unique to Pacific or California. It does, however, state its interest in highest quality customer services which affect its ability to market its own products. It suggests the Commission establish a process which would assist in the development of service goals. Pacific states the vast majority of its ISDN customers have rated Pacific's ISDN services as either "good" or "excellent." It observes that its ISDN services are superior to those of most other providers. In spite of these circumstances, Pacific states, it will continue to improve its services. Specific service issues are addressed below. A. Hook-Up Services Compaq/Intel and UCAN raise concerns with the time required for customers to be hooked up to ISDN. UCAN presented several witnesses who experienced long waiting periods for hook-ups, two to six weeks from the time the service was requested until it was operational. UCAN witnesses testified that ISDN field representatives missed appointments to hook up service. ISDN Users Group agrees with UCAN and Compaq/Intel that installations and repairs are not timely. Pacific responds that the average number of days between the day an ISDN order is placed and the "due" date given to the customer is 12 business days plus three business days to assess the customer's circumstances. The average number of appointments missed is 13%. B. Customer Information UCAN and Compaq/Intel allege that ISDN employees are poorly trained, unable to provide technical information about ISDN services or assist with hookups or repairs. They believe ISDN employees have misrepresented proposed rate increases. Compaq/Intel objects to Pacific's proposal to await the 1997 budgeting process to add customer service representatives to its ISDN business office even though Pacific has admitted it requires a 25% staffing increase to accommodate the requirements presented by current demand. Pacific states it has centralized its ISDN ordering so as to provide better service to its customers. Customers may order ISDN service by dialing an 800 number and receive specially trained customer representatives. Pacific also observes it has set up an ISDN "help desk" staffed by expert managers who may assist either with provisioning or maintenance of ISDN services. The average number of C. ISDN Marketing Practices Compaq/Intel allege that Pacific has failed to promote ISDN service to residential customers and has in fact discouraged use of residential ISDN service. Compaq/Intel allege that only those customers "with great persistence, patience, and ability to endure long call holding times and call transfers and to conduct multiple discussions with Pacific Bell service personnel have any hope of receiving the (ISDN) service." Compaq/Intel believe Pacific has "no interests in providing ISDN to residential customers, observing that Pacific's advertising documents generally do not mention residential service. Compaq/Intel believe evidence of Pacific's failure to market ISDN service is its witness' promise to launch a major marketing campaign if and when the Commission orders a rate increase here. It observes that Pacific notified its sales representatives that it was "de-emphasizing ISDN for the first half of 1996. UCAN offers similar comments. Pacific responds that it has promoted ISDN in the past, although "it makes no economic sense to continue a vigorous marketing effort for a service which loses money. Once the service recovers its costs, we will promote it." D. Discussion We have determined that Pacific faces no substantial competition for ISDN services in markets serving all but the largest customers. We have also found that ISDN is an important transitional technology in the deployment of information services to the public. For these reasons, Pacific is required by law to provide reasonable customer service. Pacific may not justify poor service by arguing that its rates are not recovering its costs. Its relief for rates that are not recovering costs is to seek rate increases, as Pacific has done here. Pacific's ISDN service is lacking. Some of the service problems identified by intervenors may be those which are common to offering a new and complex product such as ISDN. For example, customer service representatives may still be learning about the technical characteristics of their product and Pacific managers may yet be learning how to train customer service representatives to provide good service. Some of the service problems identified here, on the other hand, evolve from Pacific's management decisions, as Pacific admits. Pacific's witness believes that Pacific would need to increase ISDN staffing by 25% in order to accommodate demand for ISDN services, but states that Pacific does not intend to increase staffing until 1997. This admission supports the allegations of Compaq/Intel and UCAN that customers must invest considerable time and energy to subscribe to and maintain ISDN service. Another Pacific witness observes that Pacific is not promoting ISDN services to residential customers because the service does not recover its costs. Considering that ISDN is a very specialized service which is only recently offered, Pacific surely knows its residential customers will not be informed about the service unless it is actively marketed. Pacific defends its service quality by referring to the results of its customer surveys which show that 28% of its residential ISDN customers believe they have received inadequate service. Almost none of the many marketing materials Pacific uses for ISDN refer to its use by residential customers except in the most casual way. In a competitive market, Pacific could not survive if it failed to hire enough customer representatives, failed to market a new and complex product, and overlooked the concerns of 28% of its customers. We agree that some action on our part is necessary if we are to expect Pacific to provide adequate ISDN service. We do not intend to manage Pacific's products. Nevertheless, it is the Commission's obligation to assure that jurisdictional utilities provide adequate customer service where the pressures imposed by competition do not. UCAN recommends that we deny Pacific any rate increases until and unless Pacific can demonstrate marked improvements in customer service. In that context, UCAN proposes specific measurable standards for customer service. UCAN proposes that 90% of all lines be installed within five days in 1996 increasing to 95% by 1998. UCAN proposes that 95% of repairs be completed within eight hours in 1996 decreasing to four hours by 1998. Finally, it proposes that 85% of ISDN customers surveyed characterize their ISDN service as "good" or "excellent" in 1996 improving to 93% by the end of 1998. These standards, in combination with UCAN's proposal to withhold rate increases until Pacific's customer satisfaction levels for all categories of ISDN service reach 90% excellent or good, would likely provide a compelling incentive for Pacific to improve its ISDN service quality. We believe, however, that these remedies are too harsh and require too much oversight on our part. We prefer, at this time, to provide Pacific an opportunity to improve its customer services with the revenues we find reasonable based on Pacific's cost studies and with incentives that are contingent upon ongoing performance. If Pacific fails to accomplish the objectives we set forth here, we will consider further measures. We therefore direct Pacific to implement certain service standards with associated performance incentives: 1. In cases where Pacific misses an appointment with a customer for ISDN service or installation, Pacific will credit the customer $25 for each missed appointment; 2. Pacific will discount its installation charge for any customer by 10% for each day it fails to install ISDN service after 10 business days from the date of the initial order; 3. Pacific will waive the installation charge of any customer for whom Pacific has failed to install ISDN service within 15 business days from the initial order; 4. Pacific will credit customers $5 for each day repairs are not made beginning 24 hours after the customer reports the system problem. In order to provide Pacific with adequate time to satisfy the targets, the performance incentives shall not be effective until March 1, 1997, which its tariffs shall state. Pacific shall notify ISDN customers and prospective ISDN customers of these tariff provisions. Additionally, we will require Pacific to submit customer survey results every six months beginning July 1, 1997 regarding its customers' satisfaction with ISDN service. The customer surveys shall include questions eliciting customers' perceptions of: 1) the quality of repair services, 2) how well customer service representatives are trained, 3) how easily customers gain access to employees who are able to help them, and 4) installation services. If more than 10% characterize any aspect of ISDN service as "inadequate H or "poor, H we will consider whether to take further steps as necessary. ====================== Findings of Fact ====================== 1. The Commission approved Pacific's ISDN tariffs on a provisional basis in February 1993 for business ISDN services and in May 1994 for residential ISDN services. Pacific here seeks to make its provisional tariffs permanent. 2. Pacific filed a motion for approval of a settlement in this proceeding on July 17, 1996, which it subsequently withdrew because the assigned ALJ and assigned Commissioner ruled that the Commission would consider the settlement only by way of a hearing process. 3. ISDN currently has numerous applications for home and business use including data transmission for customers who telecommute or access the Internet. 4. Pacific herein requests an increase of $8 for monthly charges and other rate design changes to its ISDN tariffs, including eliminating the waiver of the installation charge for residential customers and eliminating unlimited residential usage during off-peak periods. 5. The Commission designated ISDN as a Category II service in D.96-p3-020. Pursuant to D.89-10-031, Pacific may reduce its ISDN rates but not increase them without Commission approval. 6. The Commission established basic costing principles, specifically, those reflected in the TSLRIC model, in its OANAD proceeding but deferred to this proceeding the application of those costing principles to ISDN services. 7. The Commission's policy is to promote the deployment of information technologies and to promote competition in all utility markets where possible. 8. A product or service that is priced below cost may dampen development of economic alternatives. A product or service priced above cost will either require subsidization from other services or products, or force the company to lose money on the service or product. 9. There are currently no economic alternatives to ISDN services for residential and small business customers who seek high speed data transmission. 10. Pacific justified rate changes requested in this application on the basis that its original cost estimates incorrectly assumed that only about 12% of its customers were more than 15 kilofeet from the central office and that its original cost estimates assumed incorrectly that its residential customers would use the service less off-peak than they actually use. 11. In some cases, Pacific did not adjust its actual cost study data to incorporate anticipated future costs as required by D.95-12-016. 12. Setting ISDN rates at costs precludes the possibility that Pacific will recognize extraordinary profits from ISDN services or subsidize the service with revenues from other services, consistent with Commission policy. 13. The information presented in this proceeding suggests that only those 3% of residential customers who use more than 200 hours a month of off-peak usage may contribute to system congestion. 14. Pacific's installation charges reasonably reflect the cost of the service, although its level may dampen demand if it must be paid in one billing period. 15. Pacific did not request pricing flexibility for ISDN services in this application. 16. D. 96-03-020 found generally that wholesale rates should be set at a discount of 17% from retail rates. 17. Pacific did not justify withdrawing special ISDN features from residential ISDN tariffs. 18. Pacific does not provide high quality customer services to its ISDN customers and potential ISDN customers and does not appear to promote or encourage residential customers to subscribe to ISDN services. 19. Pacific should not compromise the quality of service for a product that is not fully competitive on the basis that the service is not recovering its costs. 20. If a service is not recovering its costs, Pacific may seek rate relief for the service. 21. Pacific did not adequately demonstrate that substantially more customers are more than 13.8 kilofeet from their central offices than Pacific originally assumed. 22. Pacific did not satisfy its burden of proof that customers using more than 20 hours of off-peak usage were imposing costs on the system by creating system congestion. 23. Pacific did not satisfy its burden of proof regarding the reasonableness of including in its cost study the costs of DAML, load coils, ring generators, DTMF recognizers and dialtone generators. ====================== Conclusions of Law ====================== 1. That portion of the complaint filed by Compaq/Intel which alleges that Pacific's ISDN rates are unreasonable does not conform with the requirements of Section 1702. 2. Pacific should be ordered to modify its cost study to reflect assumptions that 12% of its business ISDN customers and 14% of its residential ISDN customers are more than 13.8 kilofeet from their central offices. 3. Pacific should be required to modify its cost study to incorporate actual data available for the first eight months of 1996 for costs associated with billing inquiries, general purpose computer expenses, and OCS and to calculate rates so that its expected rate of return is 12% but otherwise consistent with the information provided and methodology used by Pacific in this proceeding. 4. Pacific should be required to modify its cost study to incorporate the volumes it anticipates for 1997 of approximately 400,000 ISDN customers. 5. Pacific should be ordered to modify its cost study to remove the costs associated with DAML, load coils, ring generators, DTMF recognizers, and dialtone generators. 6. Pacific should be required to offer, at no additional charge, off-peak residential usage for up to 200 hours a month. Its residential ISDN tariffs should impose usage charges for the time exceeding 200 hours during off-peak periods. 7. Pacific's residential ISDN tariffs should permit residential customers to pay installation charges over a six-month period. 8. The Commission should order Pacific to propose a wholesale tariff for ISDN service which sets wholesale rates that are discounted by 17% from retail rates until and unless Pacific is ordered to the contrary by this Commission or the FCC. 9. Pacific should be required to continue to offer special ISDN features to residential customers on the same basis as they are offered to business customers. 10. The Commission should order Pacific to implement the following service performance incentives no later than March 1, 1997: a. In cases where Pacific misses an appointment with a customer for ISDN service or installation, Pacific will credit the customer $25 for each missed appointment. b. Pacific will discount its installation charge for any customer by 10% for each day it fails to install ISDN service after 10 business days. c. Pacific will waive the installation charge of any customer for whom Pacific has failed to install ISDN service within 15 business days. d. Pacific will credit customers $5 for each day repairs are not made beginning 24 hours after the customer reports the system problem. 11. Pacific should be ordered to submit to the Telecommunications Division, and any party who requests the information, results of a survey designed to determine customers' satisfaction with ISDN services. The survey should identify business and residential customers separately and should elicit information regarding customers' perceptions on the quality of repair services, how well customer service representatives are trained, how easily customers gain access to employees who are able to help them, and installation services. ====================== ORDER ====================== IT IS ORDERED that: 1. The application of Pacific Bell (Pacific)to modify its rates for Integrated Services Digital Network (ISDN) services is approved except to the extent set forth herein. Pacific shall modify its rates in conformity with findings herein regarding its cost studies, impose usage charges for residential off-peak use which exceeds 200 hours a month, and offer a wholesale ISDN service discounted by 17% from retail rates. 2. The complaint of Compaq Computer Corporation and Intel Corporation (Compaq/Intel) is granted to the extent set forth herein on matters relating to service quality. 3. Pacific shall modify its tariffs consistent with Conclusions of Law 2, 3, 4, 5, 6, 7, 8, 9, and 10, of this decision. 4. Pacific shall conduct the customer survey as set forth in Conclusion of Law 11 and submit it to the Telecommunications Division and any party who requests the information. Pacific shall submit its first survey results no later than July 1, 1997 and Submit subsequent survey results every six months unlit July 1, 1999. 5. Application 95-12-043 and Case 96-02-002 are closed. This order is effective today. Dated _____________________, at San Francisco, California.