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Promisesand RealitiesAn examination of the post-merger performance of the SBC/Pacific Telesis and Bell Atlantic/NYNEX companies

A Publication of the Public Policy Institute

Promises and Realities:An Examination of the Post-Merger Performance of the

SBC/PACIFIC Telesis and Bell Atlantic/NYNEX Companies

byScott C. Lundquist Scott A. Coleman

Economics and Technology Inc.

Christopher A. Baker, Project OfficerAARP Public Policy Institute

Research Group

The Public Policy Institute, formed in 1985, is part of the Research Group in the AARP. One of themissions of the Institute is to foster research and analysis on public policy issues of interest toolder Americans. This publication represents part of that effort. Any views expressed in this pub-lication are for information, debate, and discussion, and do not neccessarily represent formal policies of AARP.

Copyright ©1999. AARP. Reprinting only with permission

Many people contributed to the production of this report. Thomas L. Welch, Chairman of theMaine Public Utilities Commission, Bob Rowe, Commissioner at the Montana Public ServiceCommission, Dr. Mark Cooper, Research Director at the Consumer Federation of America, and SandraB. Eskin, Esquire, provided valuable critiques of the report.

The opinions expressed in this report are those of the authors. However, many thanks are due toLee L. Selywn and Susan Baldwin of ETI for their helpful suggestions during the review process,and to Sonia N. Jorge for her careful research analysis.

At AARP, Susan Weinstock and Jeff Kramer deserve special thanks for their thoughtful review com-ments and advice as does Ann McLarty Jackson for formatting the report and designing the cover.

ACKNOWLEDGEMENTS

TABLE OF CONTENTS

FOREWORD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Purpose and Methodology of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

II. REGULATORY REVIEWS OF THE RBOC MERGERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Varying Regulatory Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Regulators Concerns about the Mergers’ Potential Impact on Consumers

and the Development of Local Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

Specific Safeguards and Monitoring Requirements Established by Regulators . . . . . . . . .25

Conditions Applied to the SBC Communications/Pacific Telesis Merger . . . . . . . . . . . . .25

Conditions Applied to the Bell Atlantic/NYNEX Merger . . . . . . . . . . . . . . . . . . . . . . .26

III. ANALYSIS OF THE RBOCS’ BEHAVIOR IN THE POST-MERGER ENVIRONMENT . . . . . . . . . . . .30

Competition in local telephone service markets . . . . . . . . . . . . . . . . . . . . . . . . . . . .30

Regulatory Conditions to Reduce Entry Barriers . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

Market-Preserving Conduct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33

Measuring Local Service Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36

Retail Rates for Basic Telephone Service and the Flow-through

of Merger Cost Savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41

Merger Cost Savings from Bell Atlantic/NYNEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41

Merger Cost Savings from SBC Communications/Pacific Telesis . . . . . . . . . . . . . . . . . . .43

Retail Service Quality and Pace of Network Investment . . . . . . . . . . . . . . . . . . . . . . .45

Post-Merger Service Quality for Customers of Pacific Bell . . . . . . . . . . . . . . . . . . . . . .46

Post-Merger Service Quality for Customers of Bell Atlantic/NYNEX . . . . . . . . . . . . . . . .49

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55

IV. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57

Promises and Realities 3

APPENDICESAppendix A: List of Common Telecommunications Industry Acronyms . . . . . . . . . . . .61

Appendix B: Pre- and Post-Merger Service Quality for Bell Atlantic-North (NYNEX) States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63

Appendix C: Pre- and Post-Merger Service Quality for Nevada-Bell . . . . . . . . . . . . . .71

Appendix D: Pre- and Post-Merger Service Quality Complaints to State Commission for Bell-Atlantic-New England, Bell-Atlantic-New York, Pacific Bell-California,and Nevada-Bell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73

FIGURES AND TABLESFigure 1: Pre SBC/Pacific Telesis and Bell Atlantic/NYNEX Mergers: Access Line Shares (1996). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Figure 2: Post SBC/Pacific Telesis and Bell Atlantic/NYNEX Mergers: Access Line Shares (1997). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

Figure 3: Competitive Entry into the Local Market, Nationwide . . . . . . . . . . . . . . . .37

Figure 4: Percent of Total RBOC Lines Served by CLECs Using Resold Lines or UNE Loops . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39

Figure 5: The Scope of the ILEC Networks Remains Vastly Larger than that of the CLECs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41

Table 1-A: Pacific Bell Pre- and Post-Merger Service Quality . . . . . . . . . . . . . . . . . . .47

Table 1-B: Pacific Bell Pre- and Post-Merger Customer Dissatisfaction . . . . . . . . . . . . .48

Table 2-A: Bell Atlantic - New York Pre- and Post-Merger Service Quality . . . . . . . . . .51

Table 2-B: Bell Atlantic - New York Pre- and Post-Merger Customer Dissatisfaction . . . .52

Table 3-A: Bell Atlantic - Massachusetts Pre- and Post-Merger Service Quality . . . . . . .53

Table 3-B: Bell Atlantic - Massachusetts Pre- and Post-Merger Customer Dissatisfaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54

APPENDIX B TABLESTable B-1: Bell Atlantic - Maine Pre- and Post-Merger Service Quality . . . . . . . . . . . .63

Table B-2: Bell Atlantic - Maine Pre- and Post-Merger Customer Dissatisfaction . . . . . .64

Table B-3: Bell Atlantic - New Hampshire Pre- and Post-Merger Service Quality . . . . . .65

4 Promises and Realities

Table B-4: Bell Atlantic - New Hampshire Pre- and Post-Merger Customer Dissatisfaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .66

Table B-5: Bell Atlantic - Rhode Island Pre- and Post-Merger Service Quality . . . . . . . .67

Table B-6: Bell Atlantic - Rhode Island Pre- and Post-Merger Customer Dissatisfaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .68

Table B-7: Bell Atlantic - Vermont Pre- and Post-Merger Service Quality . . . . . . . . . . .69

Table B-8: Bell Atlantic - Vermont Pre- and Post-Merger Customer Dissatisfaction . . . .70

APPENDIX C TABLESTable C-1: Pre- and Post-Merger Service Quality for Nevada-Bell . . . . . . . . . . . . . . . .71

Table C-2: Pre- and Post-Merger Customer Dissatisfaction (Nevada Bell) . . . . . . . . . . .72

APPENDIX D TABLETable D-1: Pre- and Post-Merger Service Quality Complaints to State Commission for Bell-Atlantic-New England, Bell-Atlantic-New York, Pacific Bell-California, and Nevada-Bell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73



FOREWORD

Not long after the passage of major federal telecommunications legislationin 1996, two merger proposals were announced within weeks of eachother: SBC Communications would merge with Pacific Telesis, and BellAtlantic would merge with NYNEX. In each case, the merger candidatespromised that consumers would realize a variety of benefits as a result ofthe transaction, including improved service quality, the opportunity tochoose a different service provider, and lower telephone prices. Eachcandidate also agreed to comply with various requirements imposed bytheir respective regulators as a condition of approval. Both mergers wereapproved in 1997.

This report by Economics and Technology, Inc. (ETI), a research and con-sulting firm in Boston, provides a preliminary analysis of how well eachof the two merged companies have kept the promises that they made tothe public and met the conditions that they agreed to with regulators.More specifically, the report focuses on the commitments made by eachmerged entity with regard to service quality, price levels, and the devel-opment of local competition.

This report’s findings are particularly pertinent considering that theSBC/Pacific Telesis and Bell Atlantic/NYNEX mergers likely represent thebeginning of a consolidation trend in the telecommunications industry.This trend could reduce the number of large local companies (the sevenregional Bell operating companies and GTE) from eight in 1996 to four ifthe two currently pending mergers (SBC with Ameritech and Bell Atlanticwith GTE) are approved later this year. The information in this reportshould help policymakers and advocates assess the degree to which thecompleted mergers are, in fact, in the public interest and whether regula-tory action is necessary to counteract any negative impacts of thesemergers. The report should also enable policymakers and advocates toimprove their assessment of the potential impact of the proposed mergerscurrently under review.

Christopher A. BakerProject OfficerPublic Policy InstituteAARP


EXECUTIVE SUMMARY

The federal Telecommunications Act of 1996 committed the U.S. to atelecommunications policy direction in which competitive forces are ulti-mately expected to supplant regulation of incumbent local carriers’ localservices, including their retail price levels and service quality. An impor-tant element of this arrangement was the 14-point competitive checklist,a list of conditions that the regional Bell operating companies (RBOCs)must satisfy in order to be allowed to provide long-distance service to itslocal customers. In adopting the checklist, Congress sought to ensurethat real competition for local telephone service existed or would developwithout hindrance before the RBOCs were allowed to enter the long-dis-tance market. Proponents of the act envisioned that it would lead to anopen, fully competitive telecommunications marketplace where companieswould provide consumers with better service quality, more choices, andlower prices.

The extent to which this vision may materialize depends on numerousand varied factors. One such factor, the mergers and consolidationsoccurring in the telecommunications industry, can have major effects onthe prices, the service quality, and the level of competition available toconsumers.

The first RBOC mergers raised significant concerns with regard to theirimpact on consumers and competition. To deal with these concerns, federal and state regulators, in approving the acquisition in 1997 ofPacific Telesis, parent company of Pacific Bell and Nevada Bell, by SBC andthe merger of Bell Atlantic with NYNEX, included a number of conditionsto ensure that each transaction served the public interest. Regulators arecurrently reviewing two mergers that present similar issues, the proposedmergers of SBC and Ameritech and of Bell Atlantic with GTE.

This study examines the impact of one specific type of merger, RBOCmergers, on consumers and on the development of local competition.Focusing on the issues of price levels, service quality, and market-openinginitiatives, the study explores how well SBC/Pacific Telesis and BellAtlantic/NYNEX have thus far fulfilled the promises and commitmentsthey made during the regulatory review process, including their level ofcompliance with any specific requirements that may have been imposedby regulators as conditions for merger approval. Given the short intervalin which the SBC/Pacific Telesis and Bell Atlantic/NYNEX mergers havebeen in effect, it is likely that the full impacts of the mergers, whether

Purpose andMethodology

Background

good or bad, have not yet materialized. Nevertheless, this preliminaryanalysis provides some empirical data and may help to identify important issues bearing on the regulatory reviews of other pending andfuture merger proposals.

In focusing on price, service quality, and competition, this report doesnot examine other changes or improvements that mergers might bring—such as new products and services, and benefits to shareholders. Nor is itpossible to determine if price, service quality, or competition would havebeen better or worse without these mergers. Instead, the paper reviewswhat has happened in the two years since the mergers occurred andwhether the promises made in applying for the mergers, and the condi-tions accepted when approval was granted, have been met.

This study is based on the analysis of publicly accessible informationobtained in the course of ETI’s participation in several of the state andfederal regulatory proceedings that have addressed the mergers. Othersources of information and analysis include reports by financial analysts,RBOC reports to shareholders, FCC reports and industry data, petitionsfiled by consumer advocate organizations.

The Federal Communications Commission (FCC) and several state regulatory commissions conducted proceedings to review the potentialbenefits and risks of the proposed SBC/Pacific Telesis and BellAtlantic/NYNEX mergers. As the merger approval decisions of the FCC andstate regulatory commissions’ merger approval decisions show, these regu-lators perceived risks that the merged companies might do the following:

l Frustrate the further growth of competition in their local service territories;

l Fail to lower prices, thus blocking “flow-through” of merger-driven cost savings to consumers; and

l Cut back on service quality and/or network investments,particularly in areas such as rural communities in which competition may develop most slowly.

Although findings regarding these risks are necessarily preliminary, theydo indicate some of the shorter-term successes and problems these firstmergers have had to date.


PrincipalFindings


Local competition. In seeking regulatory approval of their respectivemergers, SBC and Bell Atlantic promised to open their markets to localcompetition. The FCC also directed Bell Atlantic/NYNEX to undertake ninelocal market-opening actions. Thus far, Bell Atlantic has fulfilled some ofits commitments. Some of the other market-opening actions, however,have proven to be ineffective and/or impractical to enforce. Overall, inspite of the promises made by the RBOCs to open their local markets tocompetition and the application of the FCC’s nine market-opening actions,local competition is not noticeably more advanced in the former NYNEXregions compared to other parts of the country. In California, local tele-phone service competition is also developing slowly. The California PublicUtility Commission (CPUC) concluded this is due in part to shortcomings inPacific Bell’s efforts to accommodate new market entrants. In the twoyears that have passed since the Bell Atlantic/NYNEX and SBC/PacificTelesis mergers were approved, growth in local competition has continuedat a slower than anticipated pace, and the vast majority of SBC and BellAtlantic’s basic telephone customers still have no viable service choices.

Price levels. Both SBC/Pacific Telesis and Bell Atlantic/NYNEX haveachieved and even surpassed their targets for merger-driven cost savings,but only a small portion of these benefits has “flowed through” to con-sumers in the form of lower prices for basic telephone service. BellAtlantic’s merger was not subjected to any specific flow-through requirements; in addition, Bell Atlantic has not reduced basic service ratesother than as required by its pre-existing price regulation plans. WhilePacific Bell has been complying with the CPUC’s schedule of mandated ratereductions, its actual cost savings are considerably higher than the company’s earlier projections. In addition, Pacific Bell has pushed for high-er rates and changes to the regulatory framework that had required themto share revenues exceeding a benchmark rate-of-return with ratepayers.

Service quality. Pacific Bell’s service quality has declined on several basicmeasures since 1995, including number of customer complaints and averagewaiting times for repairs and new service orders. The former NYNEX regionhas shown marked improvement on some service quality measures since themerger with Bell Atlantic, including a significant decrease in the number ofcustomer complaints. Other measures, however, show no improvement andeven some degradation in service quality. The largest performanceimprovements have occurred in those states in the former NYNEX region inwhich the Public Utility Commissions (PUCs) have established aggressiveservice quality monitoring and enforcement programs. This suggests thatsuch programs can be an effective regulatory tool to ensure that an incum-bent local exchange carrier’s (ILEC) management continues to focus onservice quality issues after a merger has occurred.


The circumstances surrounding the Bell Atlantic/NYNEX merger are, inmany ways, different and independent of the circumstances surroundingthe SBC/Pacific Telesis merger. The performance of the two merged enti-ties also has differed in many respects. In general, however, several con-clusions can be drawn with regard to how well the merged companieshave thus far fulfilled the promises and commitments they made duringthe regulatory review process. The overall conclusion of this report isthat, despite various attempts by the state PUCs and federal regulators toprotect public interest during the review process, consumers to date havereceived little tangible benefit from the SBC/Pacific Telesis or BellAtlantic/NYNEX mergers.

It is, of course, too late to “undo” the completed mergers. However, thereare still opportunities for regulators to better protect consumers from thethree risks that regulators identified in approving the SBC/Pacific Telesisand Bell Atlantic/NYNEX transactions, both with respect to those twomergers and during the ongoing reviews of the proposed Bell Atlantic/GTEand SBC/Ameritech mergers. Our recommendations are that regulators dothe following:

l Quantify more precisely the full extent of merger-relatedcost savings and efficiency improvements, and adjust the pro-ductivity assumptions contained in the firms’ incentive regula-tion plans to ensure that those savings are passed through tobasic local service customers.

l Continue to carefully monitor the firms’ service quality, andbe prepared to take assertive actions, including possible impo-sition of financial penalties, to encourage the firms to complywith the mandated quality standards.

l Consider extending the more effective of the local market-opening initiatives that the FCC adopted for Bell Atlantic tothe SBC/Pacific Telesis merger, as well as to any subsequentRBOC mergers that receive approval.

l Use the Telecommunications Act’s 14-point checklist forlocal competition as a benchmark for approving RBOC mergers.

l Devise ways at the state and the federal levelto hold merging companies accountable for the promises madewhile seeking regulatory approval.

Conclusion


The final conclusion of the report, however, is that even the best-constructed regulatory conditions are unlikely to defuse the potential anticompetitive and anticonsumer impacts of mergers between RBOCs.The only way to ensure that consumers actually share in any benefits ofan RBOC merger including more choices, improved service quality, andlower prices, is for regulators to approve only those RBOC mergers forwhich effective competition exists throughout the combined region.


Figure 1. Pre SBC/Pacific Telesis and Bell Atlantic/NYNEX Mergers:Access Line Shares (1996).

NYNEX11%

Bell Atlantic13%

Other LECs8%

Bell South14% US West

10%

Ameritech12%

Pacific Telesis11%

SBC9%

GTE11%

Source: Statistics of Common Carriers, Table 2.10, 1996.

Bell Atlantic24%

GTE11%

SBC 20%

Other LDCs8%

Ameritech12%

US West10%

Bell South14%

Source: Statistics of Common Carriers, Table 2.10, 1997

Figure 2. Post SBC/Pacific Telesis and Bell Atlantic/NYNEXMergers: Access Line Shares (1997).


INTRODUCTION

Three years ago, the U.S. Congress passed the landmark Telecommu-nications Act of 1996 and launched what was intended to be a new era forthe telecommunications services industry. The federal act, together withparallel efforts occurring at the state level, replaced the long-standing fran-chise monopoly model for the supply of local telephone services with avision of an open, fully competitive marketplace. In essence, the act created a quid pro quo arrangement in which, in exchange for retoolingtheir networks and business practices to allow new competitors to enter thelocal market, the regional Bell operating companies (RBOCs - see AppendixA for a glossary of acronyms) would be permitted to compete in the lucra-tive market for interLATA toll service (i.e., long distance), as well as in theequipment manufacturing and information services markets.

A key element of this arrangement was the 14-point competitive checklist,a list of conditions that the RBOCs must satisfy in order to provide long-distance service to their local customers. In developing this list, Congresssought to ensure that real competition for local telephone service existedor would develop without hindrance before the RBOCs were allowed to enterthe long-distance market. Proponents of the act envisioned that within afew years the separate markets for local, toll, video, and enhanced telecom-munications services would be a single market, hotly contested by theRBOCs, the traditional long distance carriers, and cable television com-panies, resulting in more choices, higher quality of service, and lower pricesfor American consumers.

The extent to which this vision may materialize depends on numerous andvaried factors. One such factor, mergers and consolidations, has had pro-found effects on the telecommunications industry, especially with respectto issues of the prices, the service quality, and the level of competitionavailable to consumers since the passage of the 1996 TelecommunicationsAct.

On April 1, 1996, SBC Communications, Inc. (SBC) announced plans toacquire Pacific Telesis, parent company of Pacific Bell and Nevada Bell; fed-eral and state regulators granted approval, with conditions, in March 1997,and the transaction was completed a few days later. On April 22, 1996, BellAtlantic and NYNEX announced plans to merge, and they received allrequired state and FCC approvals (again, with certain conditions applied) byAugust 1997. In January 1998, SBC announced that it would acquire theincumbent local exchange carrier (ILEC) serving Connecticut, Southern NewEngland Telephone company (SNET), and had satisfied all regulatory hurdlesby October of that year. The effects of the mergers that have been approvedto date are shown graphically in Figures 1 and 2.

Background

More recently, in May 1998, SBC announced plans to merge withAmeritech, and two months later, Bell Atlantic indicated its intention tomerge with GTE (often considered the “eighth RBOC”). Both of the lattermergers are currently pending, but if allowed to go forward, the numberof large incumbent local exchange carriers (ILECs) will have been cut fromthe eight that existed in 1996 to only four, with the two largest firmscontrolling some 74 percent of all local service access lines in the US.1

These RBOC mergers have raised a number of concerns with some regulators and other telecommunications industry stakeholders, includingconsumer groups and potential new competitors. While the merging companies have relied upon promises of future benefits from the mergersto gain regulatory approval, other industry participants and some regulators have called into question the potential impact of RBOC consolidation on such fundamental issues as the rate levels, service quality, and, perhaps most important in the long run, the further devel-opment of competition in the local and toll services markets.

This study is intended to examine the effects of one specific type ofmerger, RBOC mergers, upon these three fundamental consumer issues inlight of conditions established by regulators to protect the public interestand promises made by the RBOCs that future benefits would result fromthe mergers. This study focuses upon the impact of the SBC/PacificTelesis and Bell Atlantic/NYNEX mergers, which were the first to receiveFCC and state approval. In addition, it provides recommendations forconsumer safeguards that regulators should consider before the currentlypending mergers (SBC/Ameritech and Bell Atlantic/GTE) are allowed to gointo effect.

While it is important to begin gauging the impact of these mergers, itmust be noted that the relatively short time period since they each tookeffect is not nearly sufficient for their full impact, whether good or bad,to develop and be felt by consumers.


1 Based on 1997 data reported in the FCC Statistics of Common Carriers, out of approximately 150million total access lines, a merged SBC/Ameritech would control some 53 million lines (35 per-cent) and a merged Bell Atlantic/GTE would control 57.7 million lines (39percent).

Purpose andMethodology of Study


Indeed, it could be many years before the full outcome of these mergers,both individually and collectively, is known and understood. For example,benefits to consumers resulting from the merging firms’ ability to fullyintegrate their internal processes and adopt “best practices” so as to real-ize the cost savings and synergies may take more than two or three yearsto develop. Disadvantages to consumers, such as potential price increases,may also develop later, or indeed, even be postponed if the companieshope to win regulatory approval for subsequent mergers. Even though toolittle time has elapsed to evaluate fully the first two major RBOC mergers,it is valuable to review the evidence that is now available. This initialreview can identify shortcomings in previous merger approvals as well asissues that should be addressed in pending merger review proceedings.

In focusing on price, service quality, and competition, this paper does notexamine other changes or improvements that mergers might bring—such asnew products or services and benefits to shareholders, among other things.The paper also does not claim that problems with these three consumerissues would not have occurred or would have been worse or better with-out the mergers; the paper only looks at what has happened in the twoyears since the mergers occurred and whether the promises made in applying for the mergers, and the conditions accepted when approval wasgranted, have been met.

This study is based upon the analysis of publicly accessible informationobtained in the course of ETI’s participation in several of the state and federal merger-related regulatory proceedings. Other sources of informa-tion and analysis include reports by financial analysts, RBOC reports to shareholders, FCC reports and industry data, and information from the consumer perspective in petitions filed by consumer advocate organizations.

II. Regulatory Reviews Of The RBOC Mergers

Before the SBC/Pacific Telesis and Bell Atlantic/NYNEX mergers were con-summated, they were reviewed by the FCC and the state PUCs with juris-diction over the areas served by the RBOC being acquired. In all, ninesuch regulatory investigations took place, including two at the FCC2 andin California, Maine, Massachusetts, Nevada, New Hampshire, New York,and Vermont.3 Since no “change of control” was involved, regulatoryapprovals typically were not required in jurisdictions served by theacquiring RBOC (i.e., the pre-merger SBC and Bell Atlantic states).4 Thegeneral role of the investigations that were undertaken was to ensurethat the mergers would be in the public interest. However, each reviewwas governed by the regulators’ interpretations of their specific statutoryobligations for ILEC merger reviews, which varied by jurisdiction and cir-cumstance.

For example, the FCC was obligated to ensure that “the public interest,convenience and necessity will be served” by the transfer of control.5During its review of the SBC/Pacific Telesis merger, the FCC interpretedthis requirement narrowly, focusing solely on the merger’s potential nega-tive impacts on competition, and concluded that “[a] demonstration thatbenefits will arise from the transfer is not, however, a prerequisite to ourapproval, provided that no foreseeable adverse consequences [to competi-tion] will result from the transfer.”6


2FCC File No. NSD-L-96-10, Memorandum Opinion and Order, released August 14, 1997 (FCC BA/NYNEXMerger Decision); FCC Report No. LB-96-32, Memorandum Opinion and Order, released January 31,1997 (FCC SBC/Pacific Telesis Merger Decision).3California PUC, Docket A.96-04-038, Decision 97-03-067, March 31, 1997 (CPUC SBC/Pacific TelesisMerger Decision); Maine PUC, Docket No. 96-388, Order (Part II), February 6, 1997 (Maine PUCBA/NYNEX Merger Decision); Massachusetts DPU, Docket No. 96-78, Decision, January 23, 1997 (Mass.DPU BA/NYNEX Merger Decision); Nevada PSC, Docket Nos. 95-3003 et al,. Decision, August 15, 1996(Nevada PSC SBC/Pacific Telesis Merger Decision); New Hampshire PUC, DR 96-220, Order No. 22,484,January 20, 1997 (NHPUC BA/NYNEX Merger Decision); New York PSC, Cases 96-C-0603 and 96-C-0599,Order Approving Proposed Merger Subject to Conditions, March 21, 1997 (NYPSC BA/NYNEX MergerDecision); Vermont PSB, Docket 5900, Decision, February 26, 1997 (Vermont PSB BA/NYNEX MergerDecision). The PUC of Rhode Island did not undertake a substantive merger review proceeding.4The New Jersey Board of Public Utilities reviewed the Bell Atlantic/NYNEX merger in the context ofits ongoing evaluation of NYNEX’s "Opportunity New Jersey" (ONJ) incentive regulation plan. TheBoard took steps to monitor the impacts of the merger on the company’s fulfillment of its ONJ com-mitments but did not impose new conditions. See New Jersey BPU, Docket TM96070504, SlipOpinion, May 22, 1997, at p.11. The pre-merger SBC states were Texas, Oklahoma, Kansas, Missouri,and Arkansas, to which were added the Pacific Telesis states of California and Nevada. The pre-mergerBell Atlantic states were Delaware, Maryland, New Jersey, Pennsylvania, Virginia, West Virginia, andthe District of Columbia, to which were added the NYNEX states of Maine, Massachusetts, NewHampshire, New York, Rhode Island, and Vermont.547 U.S.C. Section 310 (d).6FCC SBC/Pacific Telesis Merger Decision, at para. 2.

VaryingRegulatoryStandards


Eight months later, when addressing the Bell Atlantic/NYNEX merger, theFCC adopted a more aggressive interpretation of its mandate, finding that“[a]pplicants bear the burden of demonstrating that the proposed trans-action is in the public interest,” and defining the public interest in termsof the “broad aims of the Communications Act” of 1996, including notonly the advancement of competition, but also universal service goals andthe deployment of advanced telecommunications technologies and services.7 The result was that the FCC imposed several specific conditionsupon the Bell Atlantic/NYNEX merger (which are detailed in a later sec-tion of this chapter), whereas it granted unconditional approval to theSBC/Pacific Telesis acquisition.

Regulatory investigations at the state level varied in scope and focusdepending upon state laws. The California PUC investigation of theSBC/Pacific Telesis merger was guided by more specific California statutesthat required the PUC to evaluate the proposed merger’s impact in sevenareas (including the resulting utility’s financial health and service quality,as well as the effects upon state and local economies), and to ensure thatratepayers receive no less than 50 percent of the total forecasted eco-nomic benefits of the merger.8 In contrast, the Maine PUC needed only toconclude that the merger between Bell Atlantic and NYNEX was “consis-tent with the interests of the utility’s ratepayers and investors,” and theNew Hampshire PUC determined that its legal standard was that the merger cause “no net harm.”9 In New York, the PSC was required to fol-low only general statutory requirements for a review of any agreementaffecting a utility’s franchise or stock. The PSC also concluded, however,that the merger was reviewable because of its impacts upon NYNEX’sincentive regulation plan in New York.10 These differences in state reviewstandards influenced the particular regulatory conditions attached to eachPUC’s merger approval, which we will describe later in this chapter.

Nonetheless, it is significant that, with the exception of the FCC’s originalinvestigation of the SBC/Pacific Telesis merger, virtually every regulatoryapproval of a merger in which one or more RBOCs has been involved hasimposed conditions intended to reduce the potential for outcomes

7FCC BA/NYNEX Merger Decision, at para. 2.8CPUC SBC/Pacific Telesis Merger Decision, at 8-9, citing California Public Utilities Code, Section854.9Maine PUC BA/NYNEX Merger Decision, at 7, citing Maine 35-A M.R.S.A. Section 708; NHPUCBA/NYNEX Merger Decision at section II.A, citing Eastern Utility Associates, 96 NHPUC 236 (241),1991.10NYPSC BA/NYNEX Merger Decision, at 2-3, citing NY Public Service Law Sections 99-100, and theNYNEX Performance Regulatory Plan, para. VIII.A.5.


contrary to the public interest.11 In the next section, we highlight theregulators’ concerns about the mergers’ potential impact on consumersand the development of local competition We then consider the specificsafeguards and monitoring requirements established by regulators.

The regulatory reviews of the SBC/Pacific Telesis and Bell Atlantic/NYNEXmergers recognized that RBOC mergers posed a number of potential out-comes that would not be in the public interest. During the course ofthese review proceedings, parties critical of the mergers filed a wealth ofexpert testimony and evidence concerning these risks, which were vigor-ously challenged by the merger applicants. As a general matter, themajor stakeholders relevant to an RBOC merger include the shareholders ofeach RBOC, the customers in each RBOCs’ service territory, the companies’employees and associated unions, existing and potential competitors, andthe citizens in each community and state served by the RBOCs, inasmuchas the supply of telecommunications services affects those areas’ economic health.

Given that the SBC and Bell Atlantic mergers were driven primarily bylong-term strategic aims and were viewed positively by shareholders (asdemonstrated by the sustained rise in share prices occurring after eachmerger announcement),12 assessments of the risks to the companies’ cus-tomers and the advancement of competition were particularly prominentin the review proceedings. The regulatory reviews did not identify andaddress those risks in a uniform manner, in part because the reviews wereconducted according to different standards, as discussed above. In general, however, regulators determined that the mergers created threeprincipal risks to consumers and local competition.

1) The mergers may retard the further growth of competition in themerged firms’ local service markets.

Regulators identified two distinct means by which the SBC and BellAtlantic mergers might impair the further development of local competi-tion. First, the mergers might eliminate any prospects for competitionbetween the now-merged RBOCs, i.e., SBC and Pacific Telesis no longer

Regulators’Concerns about

the Mergers’Potential Impact

on Consumersand the

Development ofLocal

Competition

11 One exception is the Mass. DPU that declined to impose any specific conditions in its mergerapproval decision; see Mass. DPU BA/NYNEX Merger Decision. 12During the period April 1996 through February 1999, the share prices (adjusted for stock splits)of SBC and Bell Atlantic have risen by 127 percent and 95 percent, respectively, compared to an89 percent rise in the S&P 500 index over that same period. See http://chart.yahoo.com/d for“SBC” (SBC Communications), “BEL (Bell Atlantic)” , and “SPC” (Standard and Poor 500 Index),respectively, for that period.


would be potential rivals who might have eventually competed in eachother’s markets or in areas outside of both of their service territories, andthe same holds true for Bell Atlantic and NYNEX. Second, the mergedfirms might have greater incentives to block competitive entry into theirlocal markets. For example, the FCC considered whether “[a]nother likelyharmful effect of mergers of major incumbent LECs is to increase theirability and incentive to resist the procompetitive process.”13 This couldoccur either because it would be easier for the fewer remaining majorILECs to coordinate their actions to resist competition (the FCC’s primaryconcern in this area), or because the merged firms such as SBC/PacificTelesis, which intended to pursue an expensive, full-service strategy,would have stronger incentives to use the revenue streams from theirless-competitive services to finance those strategies.

The petitioning companies attempted to respond to these concerns. BothSBC and Bell Atlantic contended that they were not potential competitorsin the service territories that they proposed to acquire.14 The ILEC econ-omist testifying in support of the Bell Atlantic/NYNEX merger in Mainestated that the merger would in fact “enhance competition” in thestate.15 Moreover, Pacific Bell’s CEO attempted to reassure the CaliforniaPUC that “[t]he merger will have no effect on Pacific Bell’s policy of sup-port for opening all telecommunications markets in California to competition.”16

The risks to competitive development were a major focus of the FCC’smerger reviews, and also were addressed in the California merger reviewproceeding. The FCC ultimately concluded that the SBC/Pacific Telesismerger would not diminish potential inter-RBOC competition, and that

13California PUC Docket A.96-04-038, Direct Testimony of Dr. Richard Gilbert, July 3, 1996, at 7-9;Maine PUC Docket 96-388, Direct Testimony of William E. Taylor, September 6, 1996, at 11-13.14Ibid., at 3-4.15California PUC Docket A.96-04-038, Direct Testimony of David W. Dorman, July 3, 1996 at 14.16FCC SBC/Pacific Telesis Merger Decision, at paras. 28 and 38.


the FCC’s ongoing efforts to open up local exchange markets to competi-tion addressed the potential for anticompetitive conduct.17 The CaliforniaPUC also declined to take action in these areas.18 However, in its reviewof the Bell Atlantic/NYNEX merger, the FCC found that the merger waslikely to have important anticompetitive effects, unless specific remedieswere imposed. First, the FCC concluded that the merger would in facteliminate Bell Atlantic as a competitor to NYNEX and would thus retardcompetition.19 The FCC went on to explain in the following statementhow the increased market power of the merged companies would run con-trary to the goal of increasing competition:

Based on the evidence in the record and our analysis of competitivemarket conditions, we find the proposed merger of Bell Atlantic andNYNEX is likely to have two predictable effects. First, we concludethat the merger is likely to strengthen NYNEX’s market power againsterosion from competition and to increase the likelihood that one ormore of the most significant market participants may unilaterallyexercise market power. Second, we conclude that the mergerincreases the likelihood of coordinated interaction among the mostsignificant remaining market participants to increase (or not reduce)prices, reduce quality, or restrict output.

We further conclude that, although this remains a regulated marketenvironment, the possible increase in market power remains animportant concern. Such increased market power would be funda-mentally inconsistent with the primary policy goal of the 1996 Act –the development of competition in, and deregulation of, telecommu-nications markets.20

In response to this perceived risk, the FCC specified certain market-opening initiatives as conditions to approval of the Bell Atlantic/NYNEX merger.

17FCC SBC/Pacific Telesis Merger Decision, at paras. 28 and 38.18CPUC SBC/Pacific Telesis Merger Decision, at 54 and 91.19FCC BA/NYNEX Merger Decision, at 43. The FCC observed that Bell Atlantic had planned to entercertain NYNEX local service markets, including the New York metropolitan area, and halted thoseplans when merger discussions commenced. Ibid., at para. 44.20Ibid., at paras. 144-145.


2) The merged companies may fail to pass along billions of dollars ofmerger-driven cost savings to customers of their noncompetitive localtelephone services.

Some state regulatory commissions were concerned that competitive pres-sures might not be sufficient to force the merged RBOCs to pass thosesavings along to their local telephone customers. As expressed by theCalifornia PUC: “…[we] do not believe, as [Pacific Bell witness] Dr. Gordonclaims, that services on which Pacific has market power are such at [sic] acompetitive level either at this time or in the immediately foreseeablefuture (as determined for this purpose in this case) that a ‘flow-through’of savings from these services will be realized due to competition to satisfy the requirements of §854.”21 The New York Public Service Com-mission anticipated somewhat more optimistically that emerging competi-tion would create incentives to flow through the cost savings resultingfrom the Bell Atlantic/NYNEX merger, but also concluded that severalmeasures (described below) should be adopted to ensure that consumersreceived those benefits.22

SBC and Bell Atlantic promised that their respective mergers ultimatelywould produce cost savings in excess of a billion dollars per year, throughcorporate restructuring, elimination of redundant operations, and adop-tion of “best practices.” Bell Atlantic and NYNEX estimated their mergercost savings would approach $1 billion per year within three years of themerger, and characterized these savings as “hard, real, and certain.”23

Pacific told the California PUC that its merger with SBC would producecost savings of $366 million between 1998 and 2003.24 Like all ILECs,these companies generate the great majority of their revenues from basiclocal telephone service.25 Consequently, most of the merger-related costsavings relate to the provision of basic local services and should beexpected to flow back to local customers.26

21CPUC SBC/Pacific Telesis Merger Decision, at 20-21. As noted in footnote 8 above, section 854 is theCalifornia statute that requires that at least 50 percent of any merger benefits are allocated to ratepayers.22NYSPC BA/NYNEX Merger Decision, at 4.23 See FCC BA/NYNEX Merger Decision, at paras. 160-163.24 CPUC SBC/Pacific Telesis Merger Decision, at 21. See also the discussion in Chapter 3 of this report.25For example, 74 percent of Bell Atlantic’s 1997 revenues were generated by its local telephone opera-tions, an additional 8 percent from its directory publishing activities which are an outgrowth of its localtelephone operations, and only 18 percent from other services. Source: Bell Atlantic 1997 Annual Report.26 Nearly all of SBC’s and Bell Atlantic’s post-merger local telephone operations are subject to price regula-tion in which basic telephone rates are either frozen, capped, or indexed to inflation. Consequently, thesecompanies generally would not undertake basic service rate reductions or increases, other than thosealready required by the governing price regulation plan, that is, unrelated to the merger. However, thisdoes not mean that an RBOC would be prohibited from initiating a rate reduction; no commission wouldreject an RBOC proposal to lower basic rates as a means to pass along cost savings from a merger.


During the PUC merger reviews, the petitioning RBOCs argued that compe-tition had developed enough to ensure that their cost savings would flowthrough to consumers without any direct regulatory mandate to do so.For example, SBC and Pacific Telesis contended that “…market forces willassure that a substantial portion of economic benefits flow through toconsumers,” and also promised that their merger’s “procompetitive effectswill generate benefits to consumers which are far larger than any esti-mates of cost savings from the merger.”27

One factor bearing on SBC/Pacific Bell’s ability to deliver cost-savings andpass them through to consumers is the large premium, relative to the pre-announcement market value of the acquired firm, that SBC paid for itsacquisition of Pacific Telesis. Just prior to the SBC/Pacific Telesis mergerannouncement, Pacific Telesis stock was trading at $27.75 per share.28 Atthe time of the merger announcement (April 1, 1996), SBC was willing topay $38.56 per share, a premium of 32 percent.29 Expressed in terms oftotal capitalization (given that Pacific Telesis had 428.4 million sharesoutstanding), SBC was willing to pay a premium of $3.8 billion over thepre-announcement total value for Pacific Telesis of $11.9 billion. Thishigh premium reveals the strategic value that the RBOCs place upon otherRBOCs’ dominant market positions and longstanding customer relation-ships. It also raises the question of how SBC expects to recoup that pre-mium, generate new profits for shareholders, and also pass cost savingson to customers.

3) The merged companies may cut back on service quality and/or net-work investments, particularly in areas such as rural communities inwhich competition may develop most slowly.

The New York PSC stated at the time of the merger review that “[t]hequality of service offered by New York Telephone has been a source ofconsistent concern to us,” and observed that the company had failed tomeet service quality targets during the first year of its incentive regula-tion plan.30 Similarly, the California PUC was dissatisfied with Pacific

27California PUC Docket A.96-04-038, Direct Testimony of Lewis J. Perl (adopted by KennethGordon), July 3, 1996, Exhibit 2, at 3.28 This was Pacific Telesis’ closing stock price on Friday, March 29, 1996. CPUC Docket A.96-04-038, SBC and Pacific Telesis Merger and Plan of Agreement, Article IX, section 9.13, at 30.29Ibid. Under the merger agreement, Pacific Telesis shares would be exchanged for SBC shares at aratio of 0.733:1. SBC’s post-announcement closing price on Monday, April 1, 1996 was $49.88, producing a per-share value for Pacific Telesis shares of $36.56 (i.e., 49.88 x 0.733 = 36.56).30New York Telephone is the local telephone company serving New York state, formerly a unit ofNYNEX and now a unit of Bell Atlantic.


Bell’s pre-merger service quality and found that some aspects of the firm’sservice quality had declined since the adoption of revised procedures in1994.31

Moreover, several state regulatory commissions concluded during theirmerger reviews that service quality could be at even greater risk after themergers were approved, in part because the merged companies would belikely to focus their resources on new markets and services. The NewYork PSC indicated that “[w]e are concerned that, in pursuing the goalsfor which this merger is designed, management may fail to focus suffi-ciently on service improvement in New York, or make the timely commit-ments of investment in infrastructure and resources that are necessary forthat improvement to occur.”32 The Maine PUC stated that “[w]e are con-cerned, however, about possible deterioration of the reliability, survivabil-ity, and quality of the services offered by NYNEX after the merger,” andspecifically noted that Bell Atlantic might choose to concentrate itsinvestment in areas other than Maine.33 The California PUC alsoaddressed service quality in its SBC/Pacific Telesis merger review andfound it necessary to impose specific service quality requirements(detailed later in this chapter) as conditions to its merger approval.34

In response to such concerns, the petitioning companies promisedimprovements in service quality. The Chairman, President, and CEO ofPacific Bell testified that “[t]he merger will benefit our customers bymaintaining and enhancing our service standards.”35 Similarly, NYNEX’sVice President for Maine operations identified the merged companies’ abil-ity to “…maintain and improve quality of service and to develop andbring to market more quickly new services based on new technologies” asan important benefit of the Bell Atlantic/NYNEX merger.36 NYNEX alsoclaimed that the merger would improve service quality in Massachusetts.37

31NYPSC BA/NYNEX Merger Decision at 4-53332 Maine PUC BA/NYNEX Merger Decision at 19-20.33CPUC SBC/Pacific Telesis Merger Decision, at 74.34CPUC SBC/Pacific Telesis Merger Decision, at 74.35California PUC Docket A.96-04-038, Direct Testimony of David W. Dorman, July 3, 1996, at 12.36Maine PUC Docket 96-388, Direct Testimony of Edward V. Dinan, September 6, 1996, at 5.37Mass. DPU BA/NYNEX Merger Decision, at 3 (citing NYNEX Reply Comments).


As explained above, regulators recognized the consumer-related risksposed by the SBC/Pacific Telesis and Bell Atlantic/NYNEX mergers to vary-ing degrees in the course of their merger review proceedings. While someregulators found the evidence inconclusive or adopted “wait and see”policies emphasizing monitoring of potential problem areas, on otheroccasions regulators adopted specific safeguards intended to reduce themergers’ potential harms to ratepayers and the further progress of localcompetition. This section details the safeguards and monitoring require-ments that were adopted by those regulators granting approval to themergers.

As we observed earlier in this chapter, the FCC placed no conditions onthe approval of the SBC/Pacific Telesis merger. In contrast, the CaliforniaPUC imposed a number of conditions on Pacific Bell in its merger approvaldecision.

Flow-through of merger benefits to consumers. The California PUCdetermined that 50 percent of the forecasted economic benefits of theSBC/Pacific Telesis merger should be flowed through to ratepayers directlyin the form of rate reductions, to comply with the minimum flow-throughrequirement set by California law.38 After considering widely varyingestimates of those total economic benefits,39 the CPUC determined thatthe ratepayer share equated to $248 million on a net present-value basisand thus ordered the merged company to make annual rate reductionsranging from $47 million to $69 million during each of the first five yearsfollowing the acquisition.40

Service quality. The California PUC found that Pacific Bell was out ofcompliance with existing service quality standards for response to cus-tomer trouble report calls and ordered the merged company to meet thosestandards for at least the next five years. The PUC also declared that itwould impose penalties on Pacific Bell if the company’s service represen-tative performance did not meet applicable standards within twomonths.41

ConditionsApplied to the

SBC/Pacific TelesisMerger

38Ibid. at 21 and 25-26.CPUC SBC/Pacific Telesis Merger Decision, at 38.39 Pacific Bell estimated the total merger cost savings accruing to Pacific’s regulated operations tobe $366 million ($248 million on a net present value basis), limited to the years 1998-2003.Consumer advocates estimated those cost savings to be approximately $2 billion, based on 10- to20- year time horizons. 40Ibid., at 38-39 and Table 1. 41Ibid., at 74-75.

SpecificSafeguards and

MonitoringRequirements

Established byRegulators


Additional commitments. The PUC accepted Pacific Bell’s commitment tospend an additional $34 million (net present value) on charitable contri-butions, support for an under-served community “think-tank,” andfunding of a Community Technology Fund and a Universal Service TaskForce.42

The Nevada PSC accepted a negotiated agreement between SBC/PacificTelesis and other parties that established certain merger-related commit-ments, but in the context of a new alternative regulation plan.43 Thenew plan created a schedule for network modernization projects inNevada, tightened service quality standards, and committed the companyto flow through to Nevada ratepayers either $4 million or two percent ofthe flow-through amount determined by the CPUC, whichever was higher.44

When approving the Bell Atlantic/NYNEX merger subject to conditions,the New York PSC specifically addressed consumer advocates’ concernsthat the merger would not produce any tangible benefits for basic tele-phone service customers in the state. As a result, the PSC not only setgoals for performance improvements, it also linked the merger and theresulting efficiencies to the Company’s Performance-based IncentiveRegulatory Plan (PRP). The New York PSC set conditions for approval thataddressed the following items:

Flow-through of merger benefits to consumers. To ensure that benefitsare passed on to consumers, the PSC adopted “... standards for the reviewof requests for recovery or deferral of any costs, including exogenouscosts, cost onsets related to the opening of competitive markets, and rev-enue losses directly due to access charge reductions.” In doing so, thePSC will consider “... whether the company’s conduct has promoted thedevelopment of competition within the state; whether consumers havebenefited from competition, including price reductions greater than con-tained in the PRP; and whether consumers have shared in the cost sav-ings resulting from the merger.”45

Service Quality. Because NYNEX had failed to meet existing service quality requirements, the PSC directed the company to submit a plan toensure the ongoing improvement of service quality in New York. This

42Ibid., at 39 and Table 1.43See Nevada PSC SBC/Pacific Telesis Decision, at Exhibit 1 (“Stipulation”).44 Ibid. at 11.45NYPSC BA/NYNEX Merger Decision, at 6-8.

ConditionsApplied to theBellAtlantic/NYNEXMerger


plan was to describe in detail the Company’s commitment to increaseinfrastructure investment by $1 billion over five years and the intentionto hire 750 to 1,000 new employees by the end of 1997 to address servicequality problems.46

Additional requirements. The PSC required that the merged Company’s“... existing major New York Telephone and NYNEX functions shall notrelocate outside of New York State.”47 Furthermore, the PSC required thatthe merged company commit to providing “timely, unimpeded and con-venient access to all books and records necessary to the conduct of theCommission’s regulatory responsibilities.”48 Finally, the PSC extended itsexisting rules governing NYNEX affiliate transactions to encompass trans-actions with any and all Bell Atlantic affiliates which affect its New Yorklocal telephone operations.49

The Maine PUC focused upon the promotion of service quality and localcompetition in its original merger review decision. The specific condi-tions that it imposed pursuant to merger approval were as follows:

Service quality. The Maine PUC ordered Bell Atlantic to maintain NYNEX’shistoric levels of network investment in the state, after concluding that“we remain concerned that incentives exist for the merged company todelay, defer, or reduce such investment in Maine.”50

Promotion of local competition. The PUC ordered Bell Atlantic to meetthe 14-point “competitive checklist” requirement set forth at Section 271of the federal Telecommunications Act by September 30, 1997, in orderto “mitigate any possible negative effect that the merger may have onthe emergence of local competition in Maine.”51 However, after BellAtlantic had failed to meet the September 1997 deadline, the PUC simplyrescinded that requirement, and has instead monitored the company’sprogress towards satisfying the checklist without imposing any furtherdeadlines or sanctions.52

46Ibid., at 4-5.47Ibid., at 4.48Ibid., at 8.49Ibid., at 8.50Maine PUC BA/NYNEX Merger Decision, at 21.51Ibid., at 17.52Maine PUC, Docket 96-388, Order, September 30, 1997.

The Vermont Public Service Board (PSB) also imposed several conditionsbefore approving the Bell Atlantic/NYNEX merger. The Board agreed inprinciple that merger-related cost savings should be passed on to ratepayers but deferred any action to do so to an appropriate forum in afuture proceeding, such as a cost-of-service case or an alternative regula-tion proceeding.53 In addition, the Board ordered the merged company tomeet the same service quality and competitive checklist obligationsapplied by the Maine PUC (see above).54 The Board also put the companyon notice that “…[w]e anticipate that NET [the company] will maintainan overall service quality that is high and that is comparable to that pro-vided in other Bell Atlantic jurisdictions, including those with consider-ably greater population density.”55

The FCC, in its order approving the Bell Atlantic/NYNEX merger, focusedupon the merger’s impact on competition and established nine specificregulatory conditions intended to eliminate entry barriers and to encourage the growth of local competition in the merged companies’region.56 These conditions – which were based on actions that BellAtlantic initially proposed to undertake to secure merger approval – canbe summarized as follows:

l Submit regular Performance Monitoring Reports (PMR)detailing the company’s performance in the ordering, provi-sioning, and maintenance of resold services, unbundled ele-ments, and interconnection trunks;

l Accept specifications for the establishment and testing ofuniform interfaces for carriers to gain access to BellAtlantic/NYNEX operations support systems;

l Offer alternative arrangements to reduce the up-front costs(by incorporating the costs into recurring charges or by allow-ing nonrecurring charges to be paid over a number of months)that competitors would face when obtaining wholesale servicesand Unbundled Network Elements (UNEs) from the company;and


53 Ibid. at 25.54 Vermont PSB BA/NYNEX Decision, at 25 and 23, respectively. The Board also required BellAtlantic to implement intraLATA toll presubscription by December 1, 1997 “or as soon thereafteras possible.” Ibid. at 24. Presubscription increases competitive choice by allowing customers toplace intraLATA (shorter-distance) toll calls using a competitive carrier on a direct “1+” basis with-out having to input an access code.55 Ibid. at 27.56FCC BA/NYNEX Merger Decision, at Appendix C (“Conditions”).


l Ensure, when it proposes rates for interconnection, transport, and termination, or unbundled network elements,that such rates are based upon the forward-looking, economiccost to provide those items.

The FCC also gave notice that its conditional approval of the BellAtlantic/NYNEX merger did not imply that such concessions would necessarily remedy regulators’ concerns with other mergers that may beproposed in the future and warned future ILEC merger candidates that:

It is quite plausible that there will be some mergers of actual or precludedcompetitors that will present such significant potential harms to competition that there will be no means to conclude that the transactionserves the public interest, convenience and necessity. The elimination ofan even more significant market participant than Bell Atlantic wouldraise even greater competitive concerns.57

As the FCC observed, each approved RBOC merger has far-reaching conse-quences for the structure of the local telecommunications marketplace.Moreover, merger approval is, for all practical purposes, irreversible once ithas occurred. For those reasons, it is particularly important to examinethe conduct of SBC and Bell Atlantic after their respective mergers wereconditionally approved.

The remainder of this paper reviews, to the extent possible given currentdata, the degree to which the RBOCs have fulfilled their promises and metthe conditions under which their respective mergers were approved.

57Bell Atlantic/NYNEX Merger Decision, at para. 179.


III. Analysis of the RBOCS’ Behavior in the Post-Merger Environment

As explained in Chapter 2 of this report, the SBC/Pacific Telesis and BellAtlantic/NYNEX mergers were approved, subject to the merged companies’fulfillment of certain conditions. While the particular conditions variedfrom jurisdiction to jurisdiction, the most important conditions focusedon the mergers’ potential impacts in the following areas:

l The opening of local telephone service markets to competition, including the removal of barriers to entry by newsuppliers;

l The incumbents’ retail price levels and flow through ofmerger cost savings; and

l The incumbents’ retail service quality and pace of networkinvestment.

This chapter examines the merged companies’ performance in each ofthese areas in turn and begins to answer the question of whether theyhave in fact met their commitments to regulators. It should be borne inmind that both mergers are relatively recent events: the SBC/PacificTelesis merger has been in place for less than two years, and the BellAtlantic/NYNEX merger has existed for about a year and a half. Given thehuge scale and complexity of these four RBOCs, it will likely take severalmore years for the full impact of their mergers to be felt by customersand competitors. Nevertheless, this preliminary analysis provides someempirical data concerning the short-term successes and problems of thefirst mergers and may help to identify important issues bearing on theregulatory reviews of other pending and future merger proposals.

At the time of their applications for merger approvals by state regulators,the candidate RBOC companies asserted that the mergers would be pro-competitive and would increase consumers’ service choices. For example,an economist testifying on behalf of SBC and Pacific Telesis in support ofthose companies’ California PUC merger application concluded that “themerger is procompetitive not only in the interLATA market but in the

Competition inLocal TelephoneService Markets


local exchange market as well.”58 Similarly, another RBOC-sponsoredeconomist who supported the Bell Atlantic/NYNEX merger contended that“it is likely that consumers in evolving local exchange markets willdemand traditional services and new bundles of telecommunications serv-ices of higher quality and more diversity than are presently available, andthe proposed merger will increase NYNEX’s ability to respond to thesedemands.”59

No doubt in part because it was the first RBOC merger that was con-sidered, SBC/Pacific was not subject to any specific commitments toreduce entry barriers or otherwise promote local competition. However,as we note in Chapter 2, the FCC did impose specific conditions on BellAtlantic in this area, including (1) submitting regular PMRs that detailthe company’s performance in the ordering, provisioning, and main-tenance of resold services, unbundled elements, and interconnectiontrunks, and (2) accepting specifications for the establishment and testing of uniform interfaces for carriers to gain access to BellAtlantic/NYNEX operations support systems (OSS) within 15 months fol-lowing approval.

After some initial difficulties in producing reports that met the FCC’srequirements,60 Bell Atlantic has been filing PMRs with the FCC on aquarterly basis. The PMRs track numerous dimensions of the merged com-panies’ interactions with competitive local exchange carriers (CLECs).One important measure is the “Percent Flow-Through” for the ordering ofresold services and unbundled loops, which refers to the percentage ofvalid CLEC orders received through Bell Atlantic’s electronic orderinginterfaces. A successful flow-through is one in which an order is fed intoBell Atlantic’s provisioning systems on an electronic basis, without man-ual intervention and/or correction by Bell Atlantic personnel. When com-petitors’ wholesale orders do not flow through Bell Atlantic’s ordering sys-tems, they are subjected to relatively slow and expensive manual han-dling by the company’s employees, a process that increases their cost andcan impair the competitors’ ability to deliver services to their customersin a timely fashion.

58California PUC Application No. 96-04-038, Direct Testimony of Lewis J. Perl, July 3, 1996,Exhibit 2 (“Economic Benefits of the Pacific Telesis-SBC Merger in California”), at p.30.59Maine PUC Docket No. 96-388, Testimony of William E. Taylor, September 6, 1996, at p.3.60 The FCC’s Accounting Safeguards Division initially was critical of the quality of Bell Atlantic’sPMR reports and indicated in a letter to Bell Atlantic that it was “concerned…about the errorrates in the submissions Bell Atlantic has filed to date.” Letter from Kenneth P. Moran, Chief,Accounting Safeguards Division, to Ms. Patricia E. Koch, Assistant Vice President, GovernmentRelations – FCC, DA 98-1228 (rel. June 24, 1998).

RegulatoryConditions toReduce Entry

Barriers


The latest PMR data (for December 1998) indicate that very few CLECorders for unbundled loops are passing through Bell Atlantic’s OSS with-out manual intervention.61 While Bell Atlantic’s handling of competitors’orders for bundled wholesale services is better, even in the best-perform-ing states, some 35-50 percent of those orders do not flow throughentirely on an electronic basis.62

Bell Atlantic’s performance on wholesale orders has been substantiallybetter in the former NYNEX territory than in the former Bell Atlantic territory.63 One would expect a substantial convergence between the twoareas, as “best practices” were adopted and OSS was optimized betweenthe two areas. In light of the continued disparity in wholesale orderingperformance, such optimization apparently has not yet materialized inthis case. Recently, Bell Atlantic has announced that it has achieved uni-form electronic OSS interfaces throughout its 14-state region.64 In thefuture, Bell Atlantic’s upgrading of these systems may eventually increaseits electronic ordering efficiency and flow-through rates from the relatively low levels that it has reported to date.

Two other conditions that the FCC attached to its approval of the BellAtlantic/NYNEX merger were that the merged firm must:

(1) offer alternative arrangements to reduce the up-front costs(by incorporating the costs into recurring charges or by allow-ing nonrecurring charges to be paid over a number of months)that competitors would face when obtaining wholesale servicesand UNEs from the company; and

61 Bell Atlantic reported a 22 percent flow-through rate for POTS UNEs in New York, a 4 percentrate in Pennsylvania, and 0 percent in the other twelve states that it operates (including its limit-ed service territory in Connecticut). Two of those states had no ordering activity, and for threeothers Bell Atlantic did not supply public data because two or fewer CLECs placed orders. BellAtlantic Performance Monitoring Report, data file downloaded from FCC, www.fcc.gov/ccb/Mergers/BA_NYNEX/perfmon.htm (file “ba4q98.exe”), at 7.02.62Ibidd., at 7.01. For the latest period (December 1998), the best flow-through rate was achievedin New Hampshire (63 percent), New York was at 50 percent, and Delaware, Maryland,Pennsylvania, Virginia, and D.C. were all under 20 percent.63Ibid., at 7.01. In December 1998, in BA-North states the flow-through rate for resale ordersranged between 40 percent and 63 percent, while in BA-South it ranged between 6 percent and 18percent. 64 Report of Bell Atlantic on Compliance with Merger Conditions, February 1, 1999, at 4 (BellAtlantic Compliance Report). This report can be downloaded fromwww.fcc.gov/ccb/Mergers/BA_NYNEX.


(2) ensure, when it proposes rates for interconnection, trans-port, and termination, or unbundled network elements, thatsuch rates are based upon the forward-looking, economic costto provide those items.

Neither of these conditions appears to have been particularly effective.Bell Atlantic indicates that it has made available various installmentplans for CLEC payment of nonrecurring charges, but that thus far therehas been very little demand for these options.65 Bell Atlantic also statesthat all of its proposed prices for interconnection and UNEs, both beforeand after the merger, have been based on forward-looking economiccosts.66 Whether the CLECs and other parties would agree with the com-pany’s assessment is unclear. Moreover, this condition is impractical forthe FCC to enforce, since a cost study must be subject to detailed andcomprehensive examination to determine whether it meets the standardof forward-looking economic costs.

While Bell Atlantic has made progress in some of the areas necessary toopen up its local markets to competition, it has failed to live up to allthe promises that it made to state regulators in order to secure approvalof its merger with NYNEX. As noted in Chapter 2, in its effort to gainregulatory approval, Bell Atlantic had made commitments to the MainePUC and the Vermont PSB to satisfy the Act’s 14-point local competitionchecklist by September 30, 1997. More than a year and a half after thoseoriginal deadlines, neither commission has found Bell Atlantic to havemet the checklist’s standards for opening local markets to competition.

In the 30-odd months since the two merger announcements, telephoneconsumers in the regions of the acquired RBOCs have seen little growth intheir choices for local telephone service. As documented later in thisreport, notwithstanding RBOC claims to the contrary, local market entryby new competitive suppliers has been much slower than had been antici-pated when the 1996 Act was passed. Various regulatory agencies havedocumented the role of RBOCs, especially SBC, in making it difficult fornew local competitors to enter the market.

65 Ibid., at p.11.66 Ibid., at p.12.

Market-Preserving

Conduct


During a review of SBC’s application for Section 271 authority,67 for exam-ple, a Commissioner of the Public Utility Commission of Texas stated that:

...[t]he record is replete with examples of SWB’s [Southwestern Bell]failure to meaningfully negotiate, reluctance to implement the termsof the arbitrated agreements, lack of cooperation with customers,and evidence of behavior which obstructs competitive entry.68

During the FCC’s merger review, AT&T presented evidence that SBC spent$11 million lobbying against local competition in Texas, and the IntelcomGroup, Inc. (ICG), a competitive provider of local telecommunicationsservice, “recites a litany of alleged anticompetitive acts by SBC.”69 TheFCC ultimately concluded that none of SBC’s alleged misconduct has beenfound to violate any law.70 However, when it approved the SBC/PacificTelesis merger, the FCC made the following observation:

We also find it important that almost all of the acts alleged by AT&Tand ICG have occurred in Texas. This indicates that SBC’s market-preserving conduct may not have spread throughout its home region(to Arkansas, Kansas, Missouri, and Oklahoma). This gives us someconfidence that SBC’s acts in Texas, assuming they are anticompetitive, will not be repeated in California and Nevada.71

More than two years after that comment, the evidence suggests that SBChas not done enough to eliminate barriers to local competition in theservice territory that it acquired in California (served by its Pacific Belloperating company). In December 1998, the CPUC issued its final decisionconcerning Pacific Bell’s request for Section 271 authority.72 In that deci-sion, the CPUC adopted most of the findings and recommendations froman earlier report prepared by CPUC staff which identified several substan-tive areas in which Pacific Bell has failed to comply with the competitivemandate embodied in the 1996 Act.73

67Section 271 authority is the process whereby a local carrier applies to offer in-region long-dis-tance service.68Statement of Commissioner Judy Walsh Regarding Southwestern Bell’s section 271 Request toEnter Long Distance Market, May 21, 1998, at 1.69FCC SBC/Pacific Telesis Merger Decision, at paras. 34-35. 70Ibid., at para. 38.71Ibid.72CPUC Docket R.93-04-003/I.93-04-002, Decision 98-12-069, December 17, 1998, at 2 andAppendix B.73On March 31, 1998, SBC-Pacific Bell filed a draft application with the CPUC to become a longdistance provider pursuant to Section 271 of the Telecommunications Act of 1996. The Final StaffReport represents the conclusions of the CPUC Telecommunications Division staff regarding SBC-Pacific’s application.


One conclusion in the Final Staff Report pertains to interconnectionagreements. The CPUC Staff determined that “interconnection agreementsare not performing as intended by either the Commission or parties to theagreements in question,”74 and identified as follows three types of prob-lems hindering interconnection agreements from performing as envi-sioned:

l [T]he provisions in interconnection agreements that allowCLECs to incorporate new network elements and services havenot produced timely results. CLECs have found this process tooslow for a competitive marketplace and lacking in tangibleresults.

l Second, the process for resolving contractual disputes isburdensome, time consuming and inconclusive.

l Third, when CLECs seek to amend interconnection agree-ments, it becomes apparent that they have unequal bargainingpower and no recourse to a neutral third party that canauthoritatively resolve disputes.75

The CPUC staff also concluded, “Pacific has not opened its market to anextent that allows CLECs a reasonable expectation of serving the massmarket.”76 In explaining how Pacific has failed to accommodate suchmass-market entry, the CPUC staff observed that:

Many carriers plan to enter the mass market through the combiningof network elements or use of unbundled loops. Unfortunately,Pacific has not demonstrated that it has in place a workable methodfor CLECs to order and provision combined elements. Unbundledloops require termination in a collocation cage; Pacific has not madeadequate collocation options available for Unbundled NetworkElement (UNE) combinations or unbundled loops. Further, Pacificdoes not yet have an automated system for processing those orders.Many of these issues are described in the report as “gating” factors.Gating factors are those barriers to robust competition that Pacifichas erected through the policies and procedures it has adopted.77

74Final Staff Report, at 2.75Ibid.76Ibid.77Ibid., at 4.


The CPUC also concurred with the staff position that Pacific Bell had metonly 4 of the 14 checklist requirements necessary to grant in-regionintraLATA authority.78 The CPUC found that “[i]n all, the picture con-veyed by the late 1996 filings revealed floundering and stalled competi-tion in the California local market…” and concluded that “[b]ecausePacific has not opened its market to an extent that allows CLECs a reason-able opportunity to serve the mass market, competition will not reach allthe segments of the telecommunications market that we and Congressintended.”79

The final test for whether local competition is succeeding, as SBC andBell Atlantic promised it would if their mergers were approved, is thedegree to which telephone customers are actually using alternative servic-es providers. In recent filings with the FCC, some of the RBOCs involvedin currently pending mergers have portrayed the growth in local competi-tion in recent months in breathtaking terms. Ameritech contends thatlocal competition in its region is “vibrant,” with growth that has “explod-ed” and been “astounding.”80 Bell Atlantic claims that it has seen a “dra-matic increase in competitive entry” and is beset by a “competitivefirestorm.”81 There is no question that competitors have started to makesome progress in penetrating some local service markets, mainly focusedon business customers within the major commercial centers of larger met-ropolitan areas. Given that the RBOCs have been long accustomed to having legalized monopolies for local service, it is not surprising thatthey may see the loss of any of their local service customers as “astounding.” In fact, however, when the actual competitive inroads thathave been achieved are evaluated relative to the size of the total localservices markets that the RBOCs control, it is clear that competition isstill in the very earliest stages of development. As explained below, theavailable data show that the service territories acquired by SBC and BellAtlantic have fared no better than other areas of the country in terms ofcompetitive entry and in some respects have performed relatively worse.

The FCC’s Common Carrier Bureau has been compiling data on the extentto which the RBOCs (and other large ILECs such as GTE) are supplyingessential facilities and services to CLECs, which in turn use them to provide competitive local telephone services. Three measures are

MeasuringLocal ServiceCompetition

78 Ibid., at 2.79 Ibid., at Findings of Fact Nos. 1 and 23.80FCC Common Carrier Docket 96-262, Ameritech Comments, October 26, 1998, at p.6.81FCC Common Carrier Docket 96-262, Bell Atlantic Comments, October 26, 1998, at pp.8 and 10.

particularly important. “Total service resale” (TSR) lines are localexchange lines that the RBOC supplies on a discounted, wholesale basis toCLECs, who resell them as retail local telephone service to their cus-tomers. Alternatively, the CLEC may purchase only the transmission(loop) portion of an RBOC local exchange service and combine such anUNE loop with other facilities to provide retail local telephone service.Finally, when a CLEC acquires a customer formerly served by an RBOC, thecustomer’s telephone number must be transferred or “ported” to the CLEC,which is currently accomplished by temporary arrangements known as“interim number portability” (INP). Taken together, these three measuresprovide a good indication of the degree to which new entrants have beenable to compete by attracting retail telephone customers away from theRBOCs.

Figure 3 below summarizes, on a nationwide basis, the latest availableestimates of those measures of local competition.82 As shown, within themajor RBOCs’ serving areas, only about 1.5 percent of lines were being

Total Service Resale Lines

98.54% 1.46%

Numbers Ported via IMP

0.14%99.86%

UNE Loop

0.14%99.86%

Source: Common Carrier Bureau Second Survey of Local Competition, October 28, 1998, (Numbers ported Data from First Survey, March 27, 1998.)www.fcc.gov/ccb/local_competition/survey/responses.

Figure 3: Competitive Entry into the Local Market, Nationwide.


82The resold line and unbundled loop percentages are from the FCC’s Third Local CompetitionSurvey, discussed in more detail below. The ported numbers percentage is derived from the FirstLocal Competition Survey, reflecting the market status as of year-end 1997, because this measurewas not included in subsequent Surveys.

resold on a total service resale basis, about 0.14 percent of local servicelines were being provided over UNE loops purchased by CLECs, and about0.14 percent of local numbers had been “ported” by RBOCs to competinglocal service providers via interim local number portability.83 Thus, thesemeasures indicate that, in aggregate, RBOCs continue to supply roughly98-99 percent of the retail local telephone service provided over theexisting, non-CLEC infrastructure.

The FCC does not collect data that distinguishes competitive local serviceprovided to residential versus business customers. However, available evi-dence suggests that most of the local competition occurring todayrelates to business customers, not residential customers. Many CLECs(e.g., Teleport Communications Group, now owned by AT&T, andMetropolitan Fiber Systems, acquired by MCI) began as “competitiveaccess providers” (CAPs) offering specialized services to long distancecompanies and larger businesses. In addition, most CLECs’ networks havestarted with facilities in the higher-density regions of metropolitan areas,which tend to contain more business locations than residences. Finally,business customers typically generate much higher revenue per line thando residential customers, so that they are much more attractive to serve,particularly in the early stages of competitive entry when CLECs’ capitalcosts and other start-up costs are high.

This emphasis on business customers was confirmed by a survey conduct-ed by the National Association of State Utility Consumer Advocates(NASUCA), which found that in seven states and the District of Columbiaonly 22 out of 250 authorized CLECs were providing service to any resi-dential customers. Moreover, 10 out of the 22 indicated that their resi-dential service focused on the niche market of offering prepaid service totransients and customers with bad credit histories.84


83The FCC’s statistic for ported numbers is independent of the value for unbundled loops. Localnumbers must be “ported” when an ILEC’s existing local service customers take service from a CLECthat is providing its own switching and desire to keep their local phone number. The total quan-tity of such numbers provides a reasonable proxy for the total number of CLEC lines provided overCLEC, as opposed to ILEC, facilities. While the number does not include CLEC-provided local serv-ice lines where the customer did not desire to keep the same phone number (e.g., new serviceinstallations, out-going only trunks, and computer and fax lines), it does include some percentageof lines that are also included in the UNE loop counts (situations where the CLEC combines an ILECUNE loop with its own switching).84 See “Reports Show Local Competition Develops Slowly, Unevenly,” State Telephone RegulationReport, Vol. 16, No. 26 (December 25, 1998), at 4.

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

Am

erite

ch

BA

(O

ld)

BA

(N

YN

EX

)

Bell

South

SB

C (

old

)

SB

C (

Pac

Tel)

US

West

Resold Lines

UNE Loops

Figure 4: Percent of Total RBOC Lines Served by CLECs UsingResold Lines or UNE Loops

Source: FCC Common Carrier Bureau Third Survey of Local Competition,February 28, 1999


Closer examination of the FCC data confirms the RBOCs’ continued domi-nance in local telephone markets. Figure 4 summarizes the key results ofthe FCC’s Third Local Competition Survey, which estimates lines in serviceas of September 30, 1998. Figure 4 presents the FCC data by the pre-merger regional Bell holding company groups, including the former NYNEXand the former Pacific Telesis regions, to facilitate comparisons. Asshown, no region, including the former NYNEX and Pacific Telesis states,has achieved more than a 3 percent share of resold lines, or a 0.4 percentshare of unbundled loops.85

85 In evaluating these figures, it is important to bear in mind that resold services are not “com-petitive losses,” per se, in that the RBOC continues to furnish the underlying service even thoughthe retail provider (who deals with the end-user customer) is a new entrant. For many products inother industries, e.g., books, supermarket foods, or pharmaceuticals, retail distribution by a non-affiliated reseller is the rule, not the exception.

While some additional number of competitively-provided lines are sup-plied by CLECs relying upon their own facilities, many of the CLECs reportthis data to the FCC on a confidential, nonpublic basis, and it is difficultto obtain from other sources due to competitive reasons and the stream-lined regulation often applying to CLECs. However, SBC has estimatedthat, at most, slightly over one percent of the 32 million access lines inits pre-SNET seven-state operating territory are furnished by facilities-based CLECs.86 An alternative measure of the extent of facilities-basedlocal competition is to compare the total network route miles deployed byCLECs versus the RBOCs’ existing infrastructures. In the July 1998 appli-cation for license transfer approvals related to the pending BC/Ameritechmerger, those two companies claimed (without documentary support) thatCLECs have deployed some 6500 route miles of fiber optic cable in SBC’sservice territory.87 This figure, however, represents less than one percentof SBC’s total network, which consists of over 701,651 miles.88 The samelimited scope of CLEC network deployment, relative to the incumbents’existing facilities, holds true for the other RBOCs as well. Data cited bythe RBOCs confirm that the total network route mileage deployed by allCLECs combined amounted to only 0.9 percent of the RBOCs’ total net-work route mileage (including fiber and copper facilities) in 1996, andtwo percent in 1997. These comparisons are shown graphically in Figure 5.

86FCC CC Docket No. 98-141, In re Applications of Ameritech Corp., Transferor, and SBCCommunications, Inc., Transferee, For Consent to Transfer Control of Corporations HoldingsCommission Licenses and Authorizations Pursuant to Sections 214 and 310(d) of theCommunications Act and Parts 5, 22, 24, 25, 63, 90, 95, and 101 of the Commission’s Rules,Affidavit of Mr. Stephen M. Carter (July 24, 1998), Attachment 1, at p.1.87Application of Ameritech Corporation and SBC Corporation Inc. for Authority, Pursuant to Part24 of the Commission’s Rules, to Transfer Control of a License Controlled by AmeritechCorporation, (July 24, 1998) (“SBC/Ameritech Merger Filing”): Applicant’s Description of theTransaction, Public Interest Showing and Related Demonstrations, attached Comments Concerningthe Proposed SBC-Ameritech Merger, NERA (R. Schmalensee and W. Taylor), July 21, 1998, at 22.88FCC Common Carrier Bureau, Statistics of Common Carriers – 1997, Table 2.10. Combining thefigures for SBC fiber route kilometers and copper route kilometers (km), and multiplying by thekm-to-miles conversion factor of 0.6214, produces 701,651 miles.


37

3,977

79

3,967

0500

1000150020002500300035004000 ILECs

CLECs

19971996

Sources: Statistics of Common Carriers, 1996, Table 2.10, Statistics of Common carriers, Preliminary 1997, Table 2.10, USTA Comments, Attachment A (NERA Study) at 17, citing New Paradigm Resources Group, Inc.

Figure 5: The Scope of the ILEC Networks Remains Vastly Largerthan that of the CLECs.

Tota

l Rou

te M

iles

(Cop

per

and

Fibe

r)

The SBC/Pacific Telesis and Bell Atlantic/NYNEX mergers were approved inpart due to the promise of achieving several complementary public policyobjectives, including the prospect of lower prices for the companies’ basiclocal telephone services. As we observed in Chapter 2 of this report,when seeking approval of their proposed mergers, the RBOCs emphasizedthat merging would produce large economic benefits, and assured regula-tors that market forces (i.e., increasing competition) would cause a sub-stantial share of those benefits to be passed through to consumers in theform of lower rates. This section of our report examines the extent towhich the pass-through of merger-driven cost savings has occurred.

As we described in Chapter 2, when seeking merger authorization fromthe FCC, Bell Atlantic and NYNEX projected that, within three years of themerger, they would realize merger-driven cost savings of nearly $1 billionper year. Bell Atlantic has been successful in attaining its cost reductiongoals for the merger. Bell Atlantic’s Vice President and Controller, Ms.Doreen Toben, emphasized the company’s success in the context of BellAtlantic’s pending application with the FCC to merge with GTE:

Still more recently, the experience with the Bell Atlantic/NYNEXmerger has reconfirmed that these merger efficiencies are real. Thevery substantial cost savings estimated at the time of the BellAtlantic/NYNEX merger were subsequently increased and theincreased targets are being achieved. For 1998, we projected anincreased expense savings of $450 million, and we are achievingthose savings. By 2000, we projected annual expense savings of $1.1


Merger CostSavings from Bell

Atlantic/NYNEX

Retail Rates forBasic

TelephoneService and the

Flow-through of Merger Cost

Savings


billion; we are on track to achieve those savings. In addition, for1998 and beyond, we projected annual capital savings of $300 million; we are achieving those savings as well.89

For a number of reasons, however, it appears likely that Bell Atlantic’sbasic telephone service customers will receive very little from these eco-nomic benefits. First, as described in the previous section, Bell Atlanticdoes not have meaningful competition to compel it to lower prices.Second, in approving the merger, none of the state regulatory commis-sions overseeing the local telephone operations of the Bell Atlantic andNYNEX operating companies ordered rate reductions to pass throughmerger-related cost savings to basic telephone customers.90 Third, nearlyall of the post-merger Bell Atlantic’s local telephone operations are sub-ject to price regulation in which basic telephone rates are either frozen,capped, or indexed to inflation.91 While some of these plans also include“productivity factors” to adjust prices to take into account anticipatedannual improvements in efficiency, those factors were not revised toreflect the higher cost savings that the merger has been producing.Consequently, in the states where Bell Atlantic operates under price regu-lation, it generally has not undertaken basic service rate reductions orincreases, other than those already required by the governing price regu-lation plan.92 However, this does not mean that an RBOC would be pro-hibited from initiating a rate reduction; that is, no commission wouldreject an RBOC proposal to lower basic rates as a means to pass along costsavings from a merger. In New Hampshire and Vermont, the Bell Atlanticstates that remain under rate of return regulation, there have been norate cases and thus no major adjustments to basic retail rates.93

While the post-merger Bell Atlantic’s cost savings have been partially off-set by the costs of implementing the merger, Bell Atlantic has neverthe-less been accruing large net savings from the merger rather than passingthem through to basic telephone services customers in the form of lower

89FCC CC Docket No. 98-184, Declaration of Doreen Toben, September 30, 1998 (supplied inExhibit 4 to the Application for Transfer of Control filed by Bell Atlantic and GTE), at para. 7. 90 See, e.g., the merger decisions cited in footnote 3 of this report. 91 Bell Atlantic operates under price cap regulation in all seven of its traditional territories and infour out of six of the former NYNEX states. It remains subject to rate-of-return regulation in NewHampshire and Vermont. See “Earnings Regulation for Big Incumbent Telcos Just About Extinct inEastern U.S.,” State Telephone Regulation Report, Vol. 16, No. 7 (April 3, 1998) and “Price CapsStill Struggle in Western States, but ’98 May See Some Changes,” State Telephone RegulationReport, Vol. 16, No.8 (April 17, 1998).92 An increase to Bell Atlantic’s basic local telephone rates was approved by the Maine PUC inMarch 1998, but that has occurred in the context of a rate rebalancing proceeding unrelated tothe merger. State Telephone Regulation Report, Vol. 16, No. 7 (April 3, 1998), at 3.93 In New Hampshire, a settlement reached in October 1997 concluded a case that had begunbefore the merger was approved.


rates. In 1998, Bell Atlantic realized approximately $750 million in merg-er savings ($450 million in expenses, plus $300 million in capital savings,as indicated above), offset by $196 million in merger-related transitionand integration costs,94 for net savings of about $554 million. BellAtlantic appears likely to achieve about the same level of net merger savings in 1999 as well.95

The SBC/Pacific Telesis merger presents somewhat different circumstancesbut also leads to the conclusion that the company is retaining most ofthe economic benefits of the merger. Like Bell Atlantic, SBC operatesunder price cap regulation in most of its traditional states,96 none ofwhich have experienced rate reductions for basic local telephone servicedue to the merger.97 However, as described in Chapter 2 of this report,acting under a statute that mandated the flow-through of 50 percent of amerger’s economic benefits, the California PUC ordered Pacific Bell tomake rate reductions for basic telephone services as a condition of mergerapproval. During the CPUC review of the proposed merger, the companiesestimated that their merger would achieve approximately $366 million innet merger-related cost savings in California between 1998 and 2003.98

The company study was expressly limited to operating expense savingsand thus did not reflect the additional cost savings that Pacific Bell wouldobtain on capital purchases as a result of the merger. The CPUC esti-mated those additional savings to be about $18 million per year.99 Inaccordance with the schedule of rate reductions mandated by the CPUC’smerger approval, Pacific Bell has passed through $47 million in merger-related savings to its California customers.100

94 For year 1997, Bell Atlantic recorded $519 million (pretax) in merger-related costs, $223 mil-lion of which was (one-time) employee severance costs. In 1998, Bell Atlantic recorded $196 mil-lion (pretax) in merger-related costs, the majority of which related to systems modifications. BellAtlantic, 1998 Annual Report, at 9.95 Ibid., at 9. Bell Atlantic’s 1998 Annual Report indicates that it expects to incur $100-200 mil-lion (pretax) more in transition costs before it completes its merger transition activities by year-end 1999 or mid-year 2000. 96SBC operates under price caps in Arkansas, Kansas, Missouri, and Texas, and continues to berate-of-return regulated in Oklahoma. See “Price Caps Still Struggle in Western States, but ’98May See Some Changes,” State Telephone Regulation Report, Vol. 16, No.8 (April 17, 1998).97 Because SBC was the acquiring firm, the state regulatory commissions in SBC’s traditional statesdid not undertake merger reviews during which changes to SBC’s costs might have been consid-ered.98 Ibid., at Table 1, p.2. CPUC SBC/Pacific Telesis Merger Decision, at 21. A Pacific Bell witness inthat proceeding estimated the annual expense savings, net of implementation costs and “bestpractices” benefits, to be $24 million in 1998 and were expected to rise to $227 million in 2002. .99Ibid. at Table 1, p.2.100As explained on page 14 of this report, Nevada Bell has passed through an additional $4 millionas required by the Nevada PSC, for a total of $51 million in direct consumer benefits from the merger.

Merger CostSavings from

SBC/Pacific Telesis


However, it now appears that the SBC/Pacific Telesis merger has producedsignificantly greater savings than SBC and Pacific Telesis had forecastedduring the CPUC proceeding. In a roundtable discussion at the FCC earlier this year, one of SBC’s economic consultants stated that “SBC has aproven track record in achieving projected cost savings. In the Pac Telmerger, they are ahead of schedule in achieving more than $1 billion inannual cost savings by the year 2000.”101 In addition, the procurementsavings in California had been anticipated to be 3 percent, but withinonly a year after the SBC/Pacific Telesis merger was finalized, SBC report-ed that its actual procurement savings have been in the 7-10 percentrange, more than twice the original projections.102 Accordingly, the $18million in annual capital cost savings that the CPUC had assumed actuallyhas been in the range of $43 million to $61 million.103 In light of thisinformation, it appears that the CPUC-ordered rate reductions are passingthrough to consumers a considerably smaller portion of the net cost sav-ings from the SBC/Pacific Telesis merger than the CPUC had intended.

Moreover, the basic rate decreases that have occurred in California may beoffset relatively quickly, given that Pacific Bell also has petitioned theCPUC to increase rates. An example of a rate increase that could offsetthe sharing of the merger cost savings in California is Pacific Bell’sApplication regarding directory assistance and other operator services,such as busy line verification and emergency interrupt.104 In this appli-cation, Pacific Bell seeks to decrease the monthly “free” directory assis-tance call allowance that is bundled into the basic monthly local servicerate for residential subscribers from five to three. Because customerswould be receiving less service for the same local service price, PacificBell’s request effectively raises basic monthly rates for customers thatplace four or more directory assistance calls per month. In addition,Pacific Bell’s application seeks to increase the cost of additional directoryassistance calls, that is, the cost for each call made after a customer hasfulfilled his monthly allowance of free directory assistance calls, from$0.25 to $0.50 per call with the additional flexibility to effect furtherincreases up to $1.10.

101 See FCC Docket CC-98-141, Roundtable on the Economics of Large ILEC Mergers Held onFebruary 5, 1999, transcript, at 14-15 (Dennis Carlton).102Connecticut Docket No. 98-02-20, SBC/SNET Merger, SBC Response to OCC-12; compare to CPUCSBC/Pacific Telesis Merger Decision, at 30.103 The CPUC estimated the annual capital savings at $18 million by reducing overall capital costsof $607.8 million by 3 percent. CPUC SBC/Pacific Telesis Merger Decision, at Table 1, p.2. Reducingthe $607.8 million value by 7 or 10 percent produces savings of $43 million or $61 million, respec-tively.104 Pacific Bell Application 98-05-038, In the Matter of the Application of Pacific Bell (U 1001 C),a Corporation, for Authority for Pricing Flexibility and to Increase Prices of Certain OperatorServices, to Reduce the Number of Monthly Directory Assistance Call Allowances, and Adjust Pricesfor Four Centrex Optional Features, filed May 5, 1998.


In addition to increases in directory assistance, the application requests arate increase for busy line verification from $0.50 to $2.00 per call. Suchan increase would have a negative impact on certain senior citizens’ pro-grams. In a meeting with a CPUC outreach officer, the National Council ofSenior Citizens of West Los Angeles described a program originating fromcity and county-managed senior centers wherein participants call olderpersons every day. When a line is persistently busy, members ask theoperator to perform a busy line verification, which confirms whether thephone is in use or just “off the hook,” thus implying a possible problemin the household. The centers from which these calls originate are billedfor the busy line verification. The council expressed concern to the CPUCthat if the rates are quadrupled to $2.00 per call, this important programmight have to be canceled due to escalating costs.

Rate stability in California has been threatened further by Pacific Bell’smost recent price cap filing, in which the company requested significantchanges to its regulatory framework. In this filing, Pacific Bell requestedthe elimination of “the remaining vestiges of earning/rate of return regu-lation ... including the earnings sharing mechanism, the rate of returnearnings cap and floor, the ‘benchmark’ and ‘market-based’ rates ofreturn, and the ‘trigger’ mechanism.”105 These requests were approved bythe CPUC, which thus eliminated some of the ratepayer protections thatwere part of the prior regulatory framework. In particular, the CPUCeliminated the “earnings sharing mechanism,” which required that PacificBell revenues over a benchmark rate-of-return must be shared withratepayers. The implication of eliminating the sharing mechanism is thatfuture increases in Pacific Bell’s profits — which might result from merg-er-related cost savings, rate increases following reclassification of servicesas “fully competitive,” and other sources — will accrue only to PacificBell (and its parent company SBC) and will not have to be shared withbasic telephone service customers as they formerly have been.

One of the primary concerns expressed by both regulators and intervenorsin the SBC/Pacific Telesis and Bell Atlantic/NYNEX merger proceedings atthe state level was the impact of the proposed merger on service quality,including both traditional measures of quality of service and issues suchas sales and marketing practices. This section of the report examinesthese measures and issues to help better understand the effects of thesemergers on service quality.

105Application of Pacific Bell for a Third Triennial Review of the Regulatory Framework Adopted inDecision 89-10-031, February 2, 1998, at 4.

Retail ServiceQuality and

Pace ofNetwork

Investment


California law requires that the CPUC assess whether a utility‘s change incontrol will maintain or improve the quality of service provided by theutility,106 and the CPUC specifically addressed this issue in its final deci-sion on the SBC/Pacific Telesis merger.107 In that decision, the CPUCobserved that “applicants assert Pacific’s service quality will be main-tained following the merger.”108 The CPUC acknowledged that there werepersistent problems with certain aspects of Pacific Bell’s service quality(having to do with the responsiveness of customer service representa-tives), and ultimately ordered the company to “maintain or improve itsservice quality over the five years following the merger” based on theexisting performance standards applied to Pacific Bell, which do not applyautomatic financial penalties in cases of substandard performance.109

Since that time, the CPUC opened a rulemaking proceeding to developservice quality rules applicable to all telecommunications companies,after concluding that customer surveys showed a downward trend in serv-ice quality and that customer complaints to the CPUC had increased con-siderably over the preceding five years.110 To date, the CPUC has notissued an order in that proceeding adopting new service quality rules.

While only two years have elapsed since the CPUC’s merger approval, theevidence so far indicates that in the Pacific Bell and Nevada Bell (seeAppendix C) regions service quality has continued to deteriorate in somerespects, contrary to the promises made by SBC and Pacific Telesis. Table1-A compares Pacific Bell’s pre- and post-merger retail service quality onseveral measures reported to the FCC.111 As shown therein, the company’saverage time to install local telephone service is worse than it was in1996, prior to the merger. For residential customers, the rate of initialcustomer reports of a loss of service (the measure “Out-of-Service InitialTrouble Reports – per 1000 Network Access Lines) has stayed about thesame, while initial reports of other types of service trouble (static, inter-rupted calls, etc.) have increased. (The number of business lines thatPacific Bell reported for 1998 was anomalously low and apparently inerror, so Table 1-A does not present comparable trouble report rates forbusiness customers.) The average time until resolution of an out-of-service condition (the measure “Out-of-Service Average Repair Interval,”

106California Public Utilities Code section 854(c)(2).107CPUC SBC/Pacific Telesis Merger Decision, at 72-76.108Ibid., at 72.109Ibid., at 74-75 and Ordering para. 2, respectively.110CPUC Case R.98-06-029, Order Instituting Rulemaking, June 26, 1998, at 4-5.111Performance for “ percent Commitments Met”, which measures the degree to which ILECsadhere to their scheduled dates for service installation, was relatively constant across 1996-1998for Pacific Bell (and also for the Bell Atlantic regions, discussed below), and therefore was notincluded in the tables.

Post-MergerService Quality forCustomers ofPacific Bell

which is expressed in hours) worsened for both residential and businesscustomers, the former by 71 percent. Finally, Table 1-A shows that theaverage repair intervals for other types of trouble worsened for residentialcustomers, and improved for business customers relative to their 1996levels.

1996 1997 1998 Percent Change 1996-1998

Local Services Provided to End Users

Average Installation Interval (days)Residence 1.9 2.8 2.2 16%Business 3.4 4.0 3.8 12%

Out-of-Service Initial Trouble Reports - per 1000 NALsResidence 133 138 133 0%Business 54 30 - -

All Other Initial Trouble Reports - per 1000 NALsResidence 64 63 75 16%Business 41 17 - -

Out-of-Service Average Repair Interval (hours)Residence 29.3 46.8 50.0 71%Business 14.8 16.6 17.1 16%

All Other Average Repair Interval (hours)Residence 38.0 50.0 49.2 29%Business 20.2 16.3 14.0 -31%

Source: FCC Common Carrier Bureau - ARMIS Report 43-05, Table 2A(Pacific Bell); June18, 1999.

Table 1A: Pacific Bell Pre-and Post-Merger Service Quality



Examination of Pacific Bell’s customer dissatisfaction confirms the problems suggested by the retail performance measures. Table 1-B pres-ents the results of customer surveys that Pacific Bell reports to the FCC.These data show a pronounced increase in the percentage of dissatisfiedcustomers between 1996 and 1998, particularly in their interactions withthe company’s business offices, but also with respect to service installa-tions and repairs. The number of complaints to the CPUC concerningPacific Bell also increased by more than 206 percent during that time (seeAppendix D to this report), although some of that increase may be theresult of customer confusion over who is responsible for “slamming”(unauthorized changes to a customer’s selected long distance company), asituation not attributable to Pacific Bell.

Table 1-B: Pacific Bell Pre- and Post-Merger Customer Dissatisfaction

1996 1997 1998 Percent Change 1996-1998

Repairs (% Dissatisfied)Residence 8.0 11.2 16.3 104%Small Business 7.9 9.0 9.8 24%Large Business 7.9 10 9.6 21%

Installations (% Dissatisfied)Residence 3.2 4.3 7.5 134%Small Business 4.7 6.4 10.3 119%Large Business 7.4 7.8 8.3 12%

Business Office (% Dissatisfied)Residence 2.1 2.7 6.9 229%Small Business 4.1 5.2 9.8 139%Large Business 2.7 7.1 7.7 185%

Source: FCC Common Carrier Bureau – ARMIS Report 43-06, Table I-A (Pacific Bell); June 18, 1999.

The acquisition of Pacific Telesis by SBC also does not seem to haveimproved Pacific Bell’s business practices. According to a report submit-ted to the CPUC in June 1998 by the Office of Ratepayer Advocates,deceptive business practices at Pacific Bell “are systematic and a greatdeal of pressure is brought to bear on their service representatives toadhere to the practices.”112 In the same month, the union representingPacific Bell’s sales employees filed a complaint with the CPUC allegingthat the company had unlawfully marketed and fraudulently misrepre-sented the Caller ID service, had deceptively marketed and sold certainservice packages, and had employed deceptive and unfair marketing prac-tices.113 Similar complaints were filed by the Utility Consumers’ ActionNetwork and the Greenlining Institute and Latino Issues Forum.114 Thesecomplaints were consolidated into an investigation of Pacific Bell’s mar-keting practices,115 but to date the CPUC has not issued a ruling on thematter.

In a separate, unusual action, Pacific Bell was fined $1.5 million in 1998by the United States District Court as a punitive royalty payment for“misappropriation of plaintiff’s confidential, computerized long distancebilling information.”116 This judgment, issued on August 26, 1998, foundthat Pacific had been using the databases of its competitors AT&T, MCI,and Sprint, to which it had access because of its incumbent position inthe local exchange market, to compile revenue information for over350,000 customers with the express aim of attracting high-use customersto its own service.117

In contrast to the case of Pacific Bell, retail service quality in some of theformer NYNEX states has shown significant improvement followingNYNEX’s merger with Bell Atlantic. Some of the most noticeable improve-ments have been made by Bell Atlantic’s New York operating company,formerly named New York Telephone and now known as Bell Atlantic-NewYork (BA-NY). In 1995, the New York PSC (NYPSC) adopted an alternativeregulatory framework for BA-NY called the Performance Regulatory Plan,


112Letter from Director Elena Schmid, California Office of Ratepayer Advocates, to CPUCCommissioners Bilas, Conlon, Knight, Duque, and Neeper, dated June 4, 1998.113See CPUC Case 98-04-004 et al, Administrative Judges Ruling, June 30, 1998, at 4-5.114Id. at 3-4.115Id.116AT&T Communications, et al., Plaintiffs vs. Pacific Bell, et al., Defendants, in the United StatesDistrict Court for the Northern California District, No. C 96-1691 CRB, at 7.117Ibid. See also “Judge Orders Pacific Bell to Pay $1.52M for Misuse of IXCs’ Data,”Telecommunications Reports, August 31, 1998, at p.35.

Post-MergerService Quality forCustomers of Bell

Atlantic/NYNEX


which included a fairly elaborate program for monitoring and evaluatingBA-NY’s retail service quality. This program evaluates BA-NY’s retail services performance on several quality dimensions, including the rates forcustomer trouble reports, missed appointments, and service outages, andmandates substantial rebates to BA-NY’s customers when the specified per-formance targets are not met.118

As shown in Table 2-A, during 1996-1998, BA-NY has improved its perform-ance on several, though not all, important service quality measures. Overthis period, BA-NY has greatly reduced service installation intervals andhas lowered its trouble report rates. These trends are also reflected by thesteady decline in the percentage of dissatisfied BA-NY customers over thesame period (see Table 2-B).

118 For example, the target level for customer trouble report rate in Manhattan central offices is85.0%. Failure to achieve that target can trigger rebates ranging from $5.0-million to $25-millionper year, depending upon the actual performance level. New York PSC, Case 92-C-0665, OrderApproving Performance Regulatory Plan Subject to Modification by the Commission, June 16, 1995(1995 N.Y. PUC LEXIS 296), Appendix A (Service Quality Plan), p.2.

Table 2-A: Bell Atlantic – New York Pre- and Post-Merger Service Quality

1996 1997 1998 Percent Change1996-1998


Average Installation Interval (days)Residence 2.8 0.5 0.7 -75%Business 5.7 1.0 1.2 -79%

Out-of-Service Initial Trouble Reports - per 1000 NALsResidence 202 171 178 -12%Business 99 91 91 -8%

All Other Initial Trouble Reports - per 1000 NALsResidence 97 81 74 -24%Business 41 35 32 -22%


All Other Average Repair Interval (hours)Residence 26.4 31.2 32.8 24%Business 17.0 17.5 17.4 2%

Source: FCC Common Carrier Bureau - ARMIS Report 43-05, Table 2A (BA-New York);June 18, 1999.



Table 2-B: Bell Atlantic - New York Pre- and Post-Merger Customer Dissatisfaction

1996 1997 1998 Percent Change1996-1998

Repairs (% Dissatisfied)Residence 26.26 20.95 12.27 -53.27%Small Business 24.65 21.08 12.43 -49.57%Large Business 32.06 20.99 12.49 -61.04%

Installations (% Dissatisfied)Residence 15.85 12.52 4.52 -71.48%Small Business 23.31 18.53 9.01 -61.35%Large Business 27.89 19.25 8.06 -71.10%

Business Office (% Dissatisfied)Residence 22.53 16.06 7.46 -66.89%Small Business 19.38 17.29 9.40 -51.50%Large Business 16.32 18.31 7.65 -53.13%

Source: FCC Common Carrier Bureau – ARMIS Report 43-05, Table 2A (BA-New York); June 18, 1999.

Bell Atlantic-Massachusetts has achieved roughly similar improvements inthose measures of service quality and customer satisfaction during the1996-1998 timeframe (see Table 3-A and 3-B). Like BA-NY, BA-Massachusetts faces automatic financial penalties for substandard servicequality performance. In Massachusetts, these take the form of a “ServiceQuality Index” component to the company’s price cap regulation plan.119

119See Mass. DPU 94-50, Order, May 12, 1995, at 238.

Table 3-A: Bell Atlantic - Massachusetts Pre- and Post-Merger Service

1996 1997 1998 Percent Change 1996-1998





Out-of-Service Average Repair Interval (hours)Residence 33.0 25.3 24.8 -25%Business 16.3 13.4 12.2 -25%


Source: FCC Common Carrier Bureau - ARMIS Report 43-05, Table 2A (BA-Massachusetts); June 18, 1999



Table 3-B: Bell Atlantic - Massachusetts Pre- and Post-Merger Customer Dissatisfaction

1996 1997 1998 Percent Change 1996-1998

Repairs: % DissatisfiedResidence 33.85 28.00 15.63 -53.83%Small Business 22.97 19.68 10.26 -55.33%Large Business 29.38 22.05 16.45 -44.01%

Installations: % DissatisfiedResidence 12.56 11.27 4.83 -61.54%Small Business 18.54 16.95 7.63 -58.85%Large Business 22.24 16.29 8.15 -63.35%

Business Office: % DissatisfiedResidence 10.07 9.69 5.21 -48.26%Small Business 12.56 11.53 6.44 -48.73%Large Business 10.88 19.51 10.37 -4.69%

Source: FCC Common Carrier Bureau – ARMIS Report 43-05, Table 2A (BA-Massachusetts).

As has been the case in New York and Massachusetts, the percentage ofdissatisfied customers in the other former NYNEX states has declined dra-matically between 1996 and 1998 (See Appendix B to this report, whichcontains tables of retail service quality data for Bell Atlantic in Maine,New Hampshire, Rhode Island, and Vermont). The number of customercomplaints also has been reduced significantly in all of the former NYNEXstates (See Appendix C to this report). Interestingly, however, BellAtlantic’s performance on the service quality measures does not exhibitthe same patterns of improvement in the other former NYNEX states thatare evident in New York and Massachusetts, and in particular instancesshows some signs of deterioration. While Bell Atlantic reports improve-ment in installation intervals for its operations in the remaining four NewEngland states, the average repair intervals have grown in Maine, forexample, and Vermont shows a mixed record. The time elapsed since themerger is brief, and thus the data are preliminary. The data do suggest,however, that Bell Atlantic’s management has been more responsive tostate regulators’ concerns over service quality when those concerns havebeen backed by a rigorous quality monitoring and enforcement program.


Among the various state utility commissions in the Bell Atlantic/NYNEXregion, the New York PSC appears to have established a particularly goodframework with which to evaluate the effects of the merger on the quali-ty of services provided by Bell Atlantic. The traditional measures dis-cussed above focus on retail service quality.120 Recently, however, theNYPSC expanded its service quality monitoring process to encompassintercarrier services that CLECs purchase from BA-NY in order to providecompetitive local service. The NYPSC adopted an initial set of new meas-ures developed by a working group of carrier representatives.Accordingly, BA-NY must now meet specific performance standards forsuch items as wholesale service order accuracy, wholesale billing accuracy,and the percentage of BA-NY-to-CLEC service cutovers in real-time (knownas “hot” cutovers) which are completed on schedule.121 However, theNYPSC has declined to adopt performance penalties in this area and hasdirected the working group to continue its consideration of additionalperformance measures and issues.122

This chapter has examined the post-merger performance of SBC/PacificTelesis and Bell Atlantic/NYNEX relative to the three issues that presentedthe greatest regulatory concerns, namely the RBOCs’ removal of barriers tocompetitive entry into local telephone service markets, their pass-throughof merger cost savings, and the preservation of service quality. Asdescribed in Chapter 2, during the regulatory reviews of their merger pro-posals, the RBOCs made assurances and/or commitments bearing on eachof the three areas, several of which were adopted by regulators as condi-tions for merger approval. While the full impacts of the mergers probablywill not be realized for several more years, our preliminary analysis showsthat the RBOCs’ performance has not been meeting expectations in sever-al respects, and that thus far consumers have received few tangible benefits from either merger. Our specific findings include the following:

120 The FCC also compiles data on the quality of the ILEC services offered to toll services providers(i.e., switched and special access services), as well as data on network reliability. See, e.g., TablesI-A and IV-A of the ARMIS 43-05 reports. We have not attempted to analyze these data for thisreport due to time and resource constraints. 121 New York PSC, Case 97-C-0139, Order Adopting Inter-Carrier Service Quality Guidelines,February 16, 1999 (mimeo), pps.6-8.122 Ibid., at p.3 and Appendix 3.

Summary


l Each of the merging companies contended that their merg-ers were pro-competitive. In seeking regulatory approval fromthe FCC, Bell Atlantic/NYNEX pledged to undertake nine localmarket-opening actions. Thus far, the company has fulfilledsome of its commitments. Some of the other market-openingactions, however, have proven to be ineffective and/or imprac-tical to enforce. Overall, in spite of the promises made by theRBOCs to open their local markets to competition and theapplication of the FCC’s nine market-opening actions, localcompetition is not noticeably more advanced in the formerNYNEX regions compared to other parts of the country. InCalifornia, local telephone service competition is also develop-ing slowly. The CPUC concluded this is due in part to short-comings in Pacific Bell’s efforts to accommodate new marketentrants. In the two years that have passed since the BellAtlantic/NYNEX and SBC/Pacific Telesis mergers were approved,competing local service providers have had difficulty penetrat-ing the merged RBOCs’ markets. As a result, most consumers inthe acquired RBOC regions have seen little growth in theirchoices for local telephone service.

l The merged companies have achieved and even surpassedtheir targets for merger-driven cost savings, but only a smallportion of these benefits has been passed through to consumers in the form of lower prices for basic telephone service. Bell Atlantic’s merger was not subjected to any specific flow-through requirements, and it has not reducedbasic service rates other than as required by its pre-existingprice regulation plans. While Pacific Bell has been complyingwith the California PUC’s schedule of mandated rate reductions,its actual cost savings are considerably higher than the compa-ny’s earlier projections; and nevertheless, Pacific has pushed forhigher rates and greater pricing flexibility for a number of itsretail services.

l Pacific Bell’s retail service quality has slipped in severalrespects since the SBC merger. Bell Atlantic has had a mixedrecord of post-merger service quality, with pronouncedimprovement on some quality measures in two former NYNEXstates, New York and Massachusetts, where regulators havespecified performance objectives and mechanisms for financial accountability when performance is substandard.

CONCLUSION

The circumstances surrounding the Bell Atlantic/NYNEX merger are, inmany ways, different and independent of the circumstances surroundingthe SBC/Pacific Telesis merger. The performance of the two merged enti-ties also has differed in many respects. In general, however, several con-clusions can be made with regard to how well the merged companies havethus far fulfilled the promises and commitments they made during theregulatory review process. Our overall conclusion is that, despite varyingattempts by the state PUCs and federal regulators to serve the publicinterest when approving the RBOC mergers, consumers to date havereceived relatively few tangible benefits from the mergers. As describedin the previous chapter, some of the specific commitments made by themerging RBOCs as a condition of regulatory approval either have not beenmet or have proven insufficient, particularly with respect to openingtheir local service markets to competition. Moreover, the concentrationof market power in the merged RBOCs creates powerful incentives to con-tinue to limit competitive entry, increase rates charged to captive cus-tomers, and cut back on service quality whenever it is profitable to do so.In SBC’s case, these incentives are increased because of the financial pres-sures created by the high premiums paid for their acquisition. For thesereasons, state and federal policy makers need to ensure that ubiquitous,effective competition for local telephone service exists or may developwithout hindrance before the RBOCs are allowed to merge.

It is, of course, too late to “undo” the completed Pacific Telesis andNYNEX acquisitions. However, there are still opportunities for regulatorstoimprove their protection of consumers from the detrimental trendsidentified above, both with respect to the two mergers that served as thefocus of this paper and during the ongoing reviews of the proposed BellAtlantic/GTE and SBC/Ameritech mergers. Our recommendations are asfollows:

l First, regulators should seek to quantify in more preciseterms the full extent of the cost savings and efficiencyimprovements that the acquiring firms realize from the mer-gers and identify, in particular, the savings that are attributa-ble to improvements in the provisioning of basic exchangeservices. Because these services are not likely to face wide-spread, price-constraining competition in the foreseeable



future, regulators should adjust the productivity assumptionscontained in the firms’ incentive regulation plans to ensurethat those savings are passed through to basic exchange cus-tomers.123

l Second, while regulators have already expended consider-able effort in this area, they should carefully continue to mon-itor the firms’ service quality and be prepared to take assertiveactions, including imposition of financial penalties whenappropriate, to encourage the firms to comply with mandatedquality standards. Designating a carrier working group todevise wholesale services standards, as the New York PSC hasdone, for example (see Chapter 3), appears to be an effectiveapproach, although determining nonperformance penalties inthis area probably requires direct action by regulators.

l Third, regulators should consider extending the moreeffective of the local market-opening initiatives that the FCCadopted for Bell Atlantic to the SBC/Pacific Telesis merger andto any subsequent RBOC mergers that receive approval. Asoutlined in this report, some of these conditions are flawed.Others, however, appear to be reducing some of the barriers tothe development of a competitive market in the Bell Atlanticregion and may serve as a useful starting point for creatingmore effective conditions.

l Fourth, regulators should use the Telecommunications Act’s14-point checklist for local competition as a benchmark forapproving RBOC mergers.

l Fifth, and perhaps most important, is that regulators atthe state and the federal level must devise ways to hold thesecompanies’ accountable for the promises they make while seek-ing regulatory approval. The following actions could help toimprove accountability:

q adopt concrete and verifiable conditions instead ofaccepting ill-defined commitments to future action;

123For example, the CPUC should make a significant upward increase to the “X-factor” productivityoffset value contained in the SBC’s New Regulatory Frameworks incentive regulation plan.


q use self-executing sanctions when such conditions arenot met, in order to raise the profile and credibility ofenforcement. For example, claims that a merger will resultin improved service quality should be backed up by penal-ties that are automatically implemented when commitmentsto achieve specific performance levels are not met;

q impose sanctions that are strong enough to deter viola-tors from choosing to accept the punishment over meetingthe condition.

Our final conclusion, however, is that even the best-constructed regu-latory conditions are unlikely to defuse the potential anticompetitive andanticonsumer impacts of mergers between RBOCs. In this regard, the onlyway to ensure that consumers actually share in any benefits of an RBOCmerger, including more choices, improved service quality, and lowerprices, is for regulators to approve only those RBOC mergers for whicheffective competition exists throughout the combined region.


Appendix A

List of Common Telecommunications Industry Acronyms

CLEC - competitive local exchange carrier. A new supplier of local tele-phone services (who may already supply other services, such as aninterexchange carrier or a cable television company).

ILEC - incumbent local exchange carrier. One of the traditional local tele-phone companies, which formerly provided service as regulated monopo-lies (i.e., with the exclusive right to supply local telephone services with-in their service territory).

INP - interim number portability. Interim arrangements being used byILECs to transfer (“port”) an end user’s telephone number to a CLEC, sothat the CLEC can supply retail service to the end user without a changeof telephone number.

OSS - operations support systems. Computer-based systems for adminis-tration and management of ILECs’ provision of local telephone servicesthat play a key role in service ordering and fulfillment activities.

PUC - public utilities commission. A state regulatory agency with juris-diction over utilities operating in the state, including over the price andquality of local telephone services.

RBOC - regional Bell operating company. One of the major local tele-phone units of the former Bell System, which prior to the mergers includ-ed Ameritech, Bell Atlantic, Bell South, NYNEX, Pacific Telesis, SBC, andUS West.

TSR - total service resale. Local exchange lines that the ILEC supplies ona discounted, wholesale basis to CLECs, who resell them as retail localtelephone service to their customers.

UNE - unbundled network element. A portion of an ILEC’s network, suchas a local loop or switching function, offered on an individual basis to a CLEC as a means of providing retail local telephone services.

Appendix B

Pre- and Post-Merger Service Quality for Bell-Atlantic-North (Formerly NYNEX) States

Table B-1: Bell Atlantic – MainePre- and Post-Merger Service Quality

1996 1997 1998 Percent Change1996-1998


Average Installation Interval (days) Residence 2.2 1.4 1.7 -23%Business 2.8 1.8 2.0 -29%

Out-of-Service Initial Trouble Reports - per 1000 NALsResidence 109 91 137 26%Business 47 45 62 32%

All Other Initial Trouble Reports - per 1000 NALsResidence 39 32 51 31%Business 27 21 28 4%



Source: FCC Common Carrier Bureau - ARMIS Report 43-05, Table 2A (BA-Maine); June 18, 1999.



Table B-2: Bell Atlantic - Maine Pre- and Post-Merger Customer Dissatisfaction

1996 1997 1998 Percent Change 1996-1998



Business Office: % DissatisfiedResidence 6.75 7.91 4.42 -34.52%Small Business 8.28 9.62 5.68 -31.40%Large Business 3.54 16.00 4.98 40.68%

Source: FCC Common Carrier Bureau – ARMIS Report 43-05, Table 2A (BA-Maine); June 18, 1999.

Table B-3: Bell Atlantic – New HampshirePre- and Post-Merger Service Quality

1996 1997 1998 Percent Change1996-1998




All Other Initial Trouble Reports - per 1000 NALsResidence 42 37 46 9%Business 31 23 65 110%

Out-of-Service Average Repair Interval (hours)Residence 28.3 19.8 24.3 -14%Business 11.5 11.4 11.5 0%


Source: FCC Common Carrier Bureau - ARMIS Report 43-05, Table 2A (BA-NewHampshire); June 18, 1999.



Table B-4: Bell Atlantic - New Hampshire Pre- and Post-Merger Customer Dissatisfaction

1996 1997 1998 Percent Change1996-1998



Business Office: % DissatisfiedResidence 12.22 10.09 4.78 -60.88%Small Business 11.40 11.95 6.88 -39.65%Large Business 12.14 12.04 6.95 -42.75%

Source: FCC Common Carrier Bureau – ARMIS Report 43-05, Table 2A (BA-New Hampshire).

Table B-5: Bell Atlantic – Rhode IslandPre- and Post-Merger Service Quality

1996 1997 1998 Percent Change1996-1998






All Other Average Repair Interval (hours)Residence 27.5 15.7 25.7 -7%Business 9.6 9.1 10.1 5%

Source: FCC Common Carrier Bureau - ARMIS Report 43-05, Table 2A (BA-Rhode Island); June 18, 1999.



Table B-6: Bell Atlantic - Rhode Island Pre- and Post-Merger Customer Dissatisfaction

1996 1997 1998 Percent Change1996-1998



Business Office: % DissatisfiedResidence 10.08 8.66 4.39 -56.45%Small Business 11.38 10.66 4.78 -58.00%Large Business 9.17 14.48 10.83 18.10%

Source: FCC Common Carrier Bureau – ARMIS Report 43-05, Table 2A (BA-Rhode Island); June 18, 1999.

Table B-7: Bell Atlantic – VermontPre- and Post-Merger Service Quality

1996 1997 1998 Percent Change1996-1998



Out-of-Service Initial Trouble Reports - per 1000 NALsResidence 132 121 135 2%Business 65 61 72 -11%

All Other Initial Trouble Reports - per 1000 NALsResidence 48 40 49 2%Business 36 28 29 -19%



Source: FCC Common Carrier Bureau - ARMIS Report 43-05, Table 2A (BA-Vermont); June 18, 1999.



Table B-8: Bell Atlantic - Vermont Pre- and Post-Merger Customer Dissatisfaction

1996 1997 1998 Percent Change1996-1998

Repairs: % DissatisfiedResidence 26.2 20.7 9.9 -62%Small Business 22.2 17.7 7.5 -67%Large Business 18.2 16.7 11.2 -38%

Installations: % DissatisfiedResidence 12.4 8.3 4.3 -65%Small Business 14.6 13.0 6.3 -57%Large Business 11.8 14.4 6.0 -49%

Business Office: % DissatisfiedResidence 6.5 10.4 5.9 -8%Small Business 12.5 8.9 11 -14%Large Business 5.9 23.1 0.0 -100%

Source: FCC Common Carrier Bureau – ARMIS Report 43-05, Table 2A (BA-Vermont); June 18, 1999.

Appendix C

Pre- and Post-Merger Service Quality for Nevada-Bell

Table C-1: Nevada BellPre- and Post-Merger Service Quality

1996 1997 1998 Percent Change1996-1998


Average Installation Interval (days) Residence 2.2 3.0 2.8 27%Business 3.0 3.9 2.5 -17%



Out-of-Service Average Repair IntervalResidence 18 24 18 -1%Business 18 19 15 -16%

All Other Average Repair IntervalResidence 15.5 20.5 18.2 17%Business 15.5 15.8 15.2 -2%

Source: FCC Common Carrier Bureau - ARMIS Report 43-05, Table 2A (NevadaBell); June 18, 1999.



Table C-2: Nevada-Bell Pre- and Post-Merger Customer Dissatisfaction

1996 1997 1998 Percent Change1996-1998

Repairs: % DissatisfiedResidence 2.5 5.0 8.2 228%Small Business 2.5 5.0 7.2 188%Large Business 0.0 0.0 0.0 0%

Installations: % DissatisfiedResidence 1.7 3.0 3.9 129%Small Business 2.3 2.0 4.9 113%Large Business 0.0 0.0 0.0 0%

Business Office: % DissatisfiedResidence 1.7 2.0 5.1 200%Small Business 2.7 2.0 3.7 37%Large Business 0.0 0.0 0.0 0%

Source: FCC Common Carrier Bureau – ARMIS Report 43-05, Table 2A (Nevada-Bell); June 18, 1999.

Appendix D

Table D-1: Pre- and Post-Merger Service Quality Complaints toState Commissions for Bell-Atlantic-New England, Bell-Atlantic-New York, Pacific Bell-California, and Nevada-Bell

Complaints per 100,000 Access Lines

Percent ChangeBell Atlantic 1996 1997 1998 1996-1998Maine 11.6 7.0 2.8 -75.8%Massachusetts 31.5 26.6 12.2 -61.2%New Hampshire 46.2 47.3 32.6 -29.6%New York 128.3 27.6 28.9 -77.5%Rhode Island 48.9 26.6 24.5 -49.9%Vermont 84.8 60.0 64.8 -23.5%

Pacific BellCalifornia 1.6 5.2 4.9 206.8%

Nevada Bell 7.7 5.3 15.1 97.4%

Source: FCC Common Carrier Bureau – ARMIS Report 43-05, Table 5A, Bell Atlantic New England, Bell Atlantic-New York, Pacific Bell-California,and Nevada Bell; June 18, 1999.


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