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$50 billion later, what has the Universal Service Fund accomplished?

-------- Original Message --------
Subject: 	Results from $50bn and counting USF?
Date: 	Mon, 10 Jul 2006 13:19:43 -0400
From: 	Daniel Berninger <dan@tier1research.com>
To: 	<declan.mccullagh@cnet.com>


I wrote an open letter to the commerce committees asking them to figure out
what results the $50bn collected for USF over the last 20 years achieved.

See below or  http://pulverblog.pulver.com/archives/004993.html


Daniel Berninger
VP, Sr Analyst
Tier1 Research


"Universal Service Fund generated remarkably meager results for $50 billion

* An open letter to Congressional Commerce Committees *

July 10, 2006

The Honorable Ted Stevens, Chairman
Senate Committee on Commerce, Science and Transportation

The Honorable Joe Barton, Chairman
House Committee on Energy and Commerce

Dear Chairman Stevens and Chairman Barton:

The importance of achieving universal access to telephone service motivates
a request that your committees open hearings to account for how the $50
billion spent by the Universal Service Fund (USF) over the last 20 years
contributed to the cause of universal service.

More than five million households remain without regular access to telephone
service in the United States. Penetration rates increased 2% from 1985 to
1995 as the USF consumed $7bn in the program's first decade and an
additional 1% of households got telephone service between 1996 and 2005 as
the USF spent another $43bn (see FCC Trend report). This might seem like
progress albeit small and expensive ($16,000 per additional telephone line)
until one notices the penetration rate for telephone service grew 2% in the
70's before the USF existed.

Per capita income doubled since the USF was created from $14,000 to $30,000
(see US Bureau of Economic Analysis), so one expects affordabiliy of
telephone service to improve. The income improvement probably should have
produced an even larger benefit in penetration rates, except the local
telephone monopolies increased prices at about the same pace as income
improvements. According to the FCC, the average price of a local access line
increased 70% from $14 to $24 over the period. The habit of introducing
separate charges for services formerly included in the basic rate (e.g.
activation and directory assistance) likely makes the increase for
equivalent services 100%.

The USF serves to preserves monopoly which is the root cause for our failure
to achieve universal service. The FCC's recently announced plans for USF
assessments on VoIP companies illustrates the problem. Imagine a policy
where IBM manages to extract revenue from the emerging PC industry in order
to subsidize access to 1970's era mainframes. The FCC implemented just this
policy in extracting revenues from VoIP companies to subsidize local
telephone monopolies. Even worse than a tax, the assessment gets made on
gross revenues. If some clever VoIP startup manages a 10% pre-tax income
margin like present day IBM, the FCC's 7% gross revenue assessment sends 70%
of this profit to the incumbent monopolists. A company like Vonage already
pays 30% of revenues toward terminating calls on the PSTN. Poof. Now its
37%. This sort of regulatory fiat underlies the reluctance of capital
markets to fund the competition necessary to lower prices.

The anti-competitive structure of the USF in assessing low margin
(competitive) LD revenues to subsidize high margin (monopoly) local access
defies common sense. The price increases for local telephone lines persisted
over the years even as the labor and equipment costs declined and as
competitive segments of the industry achieved significant price reductions.
Average per minute LD rates declined from 35 cents in 1983 to 5 cents
recently. The price of cellular calls decreased by a factor of 20 since
1986. Note that VoIP companies will pay into the fund, but they can't apply
for support from the fund. The FCC concluded the new assessment obligations
would have minimal impact on (monopoly) ILEC's, but the FCC did not even
feel the need to address the impact on (competitive) VoIP companies.

The FCC and Universal Service Administration Company (USAC) don't appear
concerned about the lack of results, because they don't actually track the
impact of the fund in terms of universal service metrics. The USF represents
a bureaucrat's dream, because there exists no accountability for results.
Success gets judged purely in terms of collecting and spending money. (The
USAC's annual report) does not mention penetration rates or any other metric
that might qualify as a measure of universal service (i.e. fund results)
rather than money (i.e. fund input.) The fact that the telephone industry
insiders dominating the USAC board remain silent about the lack of results
further shows the program exists to serve telephone companies not the cause
of universal service. The FCC's 150 page NPRM that accompanied the order
assessing VoIP companies does not include a single mention of how or whether
the funds contributed to the USF actually further the cause of universal

Tracking the number of households participating in the USF's Low Income
Program is as close as the FCC comes to tracking results. The monies
collected and distributed by the Low Income Program doubled from $400mn to
$800mn since 1997, but the nature of local telephone monopoly keeps people
disconnected. The program provides on average $8 per month subsidy for
qualifying low income telephone customers, but the subsidy does not solve
the affordability problem given an average telephone bill of $50 per month.
Even aside from basic rates that increase year after year, setup charges,
strict credit terms, and demand for deposits keep as many as 20% of
households in low income areas without telephone service. Competition from
VoIP companies recently led Verizon to advertise a price reduction of $17
per month (i.e. twice the USF Low Income subsidy) on its unlimited usage
plan. VoIP companies serve less than 3% of access lines, so this represents
only the beginning of the industry's competitive potential. Yet, the new USF
assessment helps defeat VoIP competition.

The lack of results deserves attention, but the lack of results coupled with
rapid growth of the fund represents a crisis. The FCC's plan to assess VoIP
does not come near to solving the funding challenges. The USF grew from
$1.5bn in the year before the changes implemented by the Telecom Act of 1996
to $6.5bn in 2005. The fund continues to grow 12% annually in recent years,
so at this pace it will double again in the next six years. LD revenues have
declined 50% from a peak in 1999, so the FCC mandated revenue assessment
grew twice as fast as the fund (from 1.2% in 1997 to 10.7% in 2005.) It does
not help matters the Bells find ways to minimize USF contributions even as
they increase their share of LD revenues. In 2005, the Bell LD division USF
contributions amounted to about 1/3 of those by the former LD pure plays
(i.e. AT&T, MCI, and Sprint) even given about equal market share positions.
Note that FCC removed USF obligations on Bell company DSL revenues at the
same time it asserted them on VoIP companies.

The Schools and Libraries Program can point to some results in getting
schools and libraries wired for Internet, but the inability of the FCC to
cope with fraud by applicants to the fund leaves the program in a shambles.
In any case, more than half of the $1 billion in funding commitments during
2005 cover the provision traditional telephone service. The disconnect
between funding commitments and disbursements exceeds 12 months in many
cases, and no competitive provider of telecommunication services can wait a
year to get paid. The school districts do not ultimately pay the bill, so
they do not complain about the fact telephone companies extract a 50%
premium above the usual $50 ARPU for bills paid through the USF. Schools end
up with expensive centrex services where they pay per minute for local
calls, 15% of the bill arises moves and adds, and 10% of monthly costs arise
from directory assistance.

The High Cost Fund (HCF) grew from $56mn in 1986 to $3.6bn in 2005. There
exists no doubt the cost of connecting customers in low density areas of the
country exceeds the costs in high density areas, but the USF's record of
collecting and spending money has worked against bringing communications to
rural areas. Keep in mind the issue of high cost revolves around the one
time fixed cost of deploying outside plant to reach remote areas. The
variable costs of delivering service in rural areas after the copper or
fiber gets deployed does not differ substantially from any other location.
The FCC's data shows the number of access lines in the 25 states that get
more from the HCF than they contribute grew from 50mn to 55mn between 1997
and 2003. Its not clear the HCF deserves credit for any of 10% increase,
because applications for HCF payments require claims of expenses not the
actual deployment of access lines. The vast majority of the money goes to
subsidizing access lines deployed before the fund existed. The expectation
of these monies actually preserves operating inefficiencies, because
reducing costs means lower HCF payments.

There will exist positive stories arising from the USF's consumption of
$50bn, but the program does far more harm than good. The fact it serves the
interest of telephone monopolies not universal service is illustrated by how
very little communication the $50bn purchased. There needs to be some
measure of accountability for the fund to further the cause of universal

Anyone that cares about the cause of universal service cannot support the
continuation of the USF as currently organized.


Daniel Berninger, Senior Analyst, Tier1 Research

Bio: Daniel Berninger joined Tier1 Research in August 2004 as Senior Analyst
covering telecom. Daniel has over a decade of experience that includes
helping to launch three prominent VoIP startups - ITXC, Vonage, and Free
World Dialup. His expertise on the intersection of telecom and the Internet
has been sought by Congress, FCC, Federal Reserve, and state PSCs. Daniel
led early VoIP deployments at Verizon, HP, and NASA for VocalTec
Communications. He won the 1999 VON Pioneer Award for co-founding the VON
Coalition and worked on the original assessment of VoIP at Bell
Laboratories. He completed doctoral studies in preparation for a Ph.D. in
System Engineering at the University of Pennsylvania.

Posted by Declan McCullagh on Jul 14, 2006 in category economics

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