PRELIMINARY ANALYSIS OF
LEC EXPENSE ACCOUNTS
Preliminary Analysis of LEC Expense Accounts
Background
Among other reasons,[1] reliance upon reported historical costs for the purpose of developing a cost factor to be used in a forward-looking cost study for basic residence local exchange service is inapropriate because many of the expenses included in the reported costs either do not support the provision of basic residential local exchange service at all, or they disproportionately support other services and/or customer classes. The illustrative analysis in this appendix examines certain accounts in the cost of service study submitted by NYNEX to the Massachusetts Department of Public Utilities[2] in order to provide some specific examples of why the ARMIS costs should not form the basis of the determination of a cost factor used in a forward-looking cost study.
The account numbers identified below and in Table App-4A correspond with the account numbers that are included with the data in the FCC Statistics of Common Carriers (e.g., Table 2.9). ETI's analysis is not intended to provide a comprehensive examination of all LEC accounts, but rather to provide specific examples that, when considered with the discussion of the return on investment and depreciation expenses in Chapter 4, demonstrate why it would be erroneous to rely upon ARMIS data to derive a cost factor to be used in a benchmark cost proxy model for basic residential local exchange service. Table App-4A simply translates the results of ETI's state-specific analysis to the national figures reported by Tier 1 companies to the FCC. Meanwhile, the Joint Sponsors have provided minimal supporting documentation for the two cost factors that were used in the BCM and, therefore, should be encouraged to provide additional information.
Account 6611: Product Management
* The Massachusetts COSS describes this account as including "costs incurred in performing administrative activities related to marketing products and services."[3] Of the approximately $46-million in expenses associated with this account in Massachusetts, a vastly disproportionate amount, i.e., 84% of the total costs, is related to market management and planning for business customers.[4] The remaining 16% is related to market forecasting and rates and tariffs for all customer classes and also to market management and planning for residential customers. It is unlikely that all of these efforts are required for universal service (e.g., it is not readily obvious that "costs incurred to identify, quantify and plan for customer requirements for new or changed communications services" supports universal service). Therefore, the upper bound that should be associated with this account is 16%.
Account 6612: Sales
* According to the Massachusetts COSS, "[t]his account contains the pay and other expenses primarily of personnel engaged in performing the functions of canvassing for new business or for changing or renewing existing service."[5] Of the five organizations associated with this account, only the Administration and System Group Sales organization performs functions potentially related to universal service (e.g., satisfying customer requests for service). This organization comprises approximately 37% of the expenses for Account 6612, so at least 63% of the expenses should be subtracted from this account. Furthermore, only 7.3% of the entire account is allocated to the residential class, which suggests that even the Administration and System Group Sales organization is primarily serving other customer classes (e.g., businesses, Centrex, etc.).[6] Therefore, this account should be reduced by at least 85%.[7]
Account 6613: Advertising
* As described in the COSS, "[t]his account includes expenses incurred in commercial advertising activities in developing and implementing promotional strategies to stimulate the purchase of products and services."[8] There is nothing in the account description to suggest that any of the advertising is of an instructional nature. This amount should be removed entirely because advertising is not necessary for primary basic local exchange service. Therefore this account should be entirely eliminated in the calculation of a forward looking cost factor for primary residential basic local exchange service.
Account 6621: Call Completion Services
* This account covers expenses associated with helping customers place and complete calls, except for directory assistance (e.g., quoting rates, etc.).[9] These expenses are entirely associated with the provision of operator services and thus belong in the cost factor only if operator services are encompassed within the scope of the universal service being costed. Approximately two-thirds of these expenses are assigned to the coin class, however, so even if operator services are being encompassed in a cost model, the expenses should be scaled back significantly from the total shown. In the Massachusetts COSS, approximately 15% of the total account is assigned to the residential class.[10] We set this amount at zero because the inclusion of operator expenses should be made explicitly and should reflect the fact that the expenses are disproportionately associated with pay telephones.
Account 6622: Number Services
* Approximately half the expenses in this account are assigned to the residential directory assistance category in the Massachusetts COSS.[11] This account includes expenses incurred in preparing, compiling and disseminating listings through directory assistance or other means. **If a directory assistance calling allowance of some sort is included within the scope of basic residential service, it is appropriate that the portion of this account attributable to the DA calling allowance be captured as a cost of universal service. In states where all DA calls are separately charged, none of these costs should be attributed to the primary residential access line.
Account 6722: External Relations
The COSS indicates that the majority of this account relates to corporate advertising, public relations, investor relations and regulatory/government relations. NYNEX allocates approximately half of these expenses to the residential class.[12] For the purpose of a forward-looking cost study, however, none of these activities support primary residential basic local exchange service and therefore this entire account should be eliminated for the purpose of determining relevant expenses.
Illustra
tive
Analysis
of LEC
Expenses
(000s
omitted)
All
Reporting
LECs
Line No. Account Item As Filed Partially
No. Corrected
(upper
bound)
255 6560 Total Depreciation and Amortization 18,994,418 13,400,000
Expenses
257 6611 Product Management 958,201 153,312
258 6612 Sales 1,934,013 290,102
259 6613 Product Advertising 600,470 0
260 6610 Total Marketing Expenses 3,492,684 443,414
261 6621 Call Completion Services 734,690 0
262 6622 Number Services 2,201,208 **??
270 6722 External Relations 764,039 0
Sources:
Statisti
cs of
Common
Carriers
,
1994/199
5,
Table
2.9;
Massachu
setts
NYNEX
Cost of
Service
Study,
12
Months
Ended
November
30,
1992.
[2]Massachusetts Cost of Service Study (COSS), NYNEX, 12 Months Ended November 30, 1992.
[3]Id., Book IV of VI, Tab H1, at 1.
[4]Id., at 3.
[5]Tab H1, at 22.
[6]By way of comparison, approximately 49% of the Building Plant Account (Account No. 2121 Tab L1, pp. 84-85 and 57% of one of the Digital Switch account (Account No. 2212.1000, at 262-263) is allocated to the residence class.
[7]If the residence class were proportionately supported by this activity, one would expect that approximately 50% of the expenses would be assigned to the residence class. Instead, only 7.3% was assigned to the residence class, i.e., approximately 14.5% of what would be expected. Therefore, the remaining approximate 85% of this account should be eliminated for the purposes of determining expenses associated with the provision of basic service.
[8]Mass. COSS, Book IV of VI, Tab H-1, at 33.
[9]COSS, Volume IV of VI, Tab H2, at 1.
[10]Most likely few of these operator services are provided in connection with local calls so arguably the entire account should be eliminated from the cacluation of a revised cost factor for basic local exchange service.
[11]Id., at 14.
[12]Tab I2, at 20, 22.