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How Telephone Companies Make How Telephone Companies Make MoneyMoney
Doug KitchDoug Kitch
Vince Vince WiemerWiemer
DiscussionDiscussion
Rate-of-Return Regulation
Revenue Requirement
Jurisdictional Separations
Cost Recovery Local Rates Access The NECA Pools Universal Service Funds
Rate-of-ReturnRate-of-Return
A method of utility regulation that provides a company with an exclusive service area but limits their earnings
The utility earns a pre-determined rate-of-return on their utility investment plus recovers allowed operating expenses and income taxes
Rate-of-Return (cont’d)Rate-of-Return (cont’d)
RoR regulation was put in place to encourage the large investments required for utilities Common for gas, electric, and
telephone utilities
The amount of money that a RoR utility is entitled to earn is called their REVENUE REQUIREMENT
Revenue RequirementRevenue Requirement
The authorized level of earnings allowed
Telephone Property, Plant & Equipment- Accumulated Depreciation = Rate Basex Rate-of-Return %= Return on Rate Base+ Operating Expenses+ Income Taxes= REVENUE REQUIREMENT
Revenue Requirement (cont’d)Revenue Requirement (cont’d)
Rate-of-Return regulation means that more plant investment and more operating expenses result in more income (revenue requirement)
Company A Company B
Telephone Plant 10,000,000$ 20,000,000$ Accumulated Depreciation - -
Rate Base 10,000,000$ 20,000,000$ Rate-of-Return 11.25% 11.25%
Return on Rate Base 1,125,000$ 2,250,000$ Operating Expenses 3,000,000 5,000,000 Income Taxes 350,000 600,000
Revenue Requirement 4,475,000$ 7,850,000$
Revenue Requirement ExampleRevenue Requirement Example
Year 1
Telephone Plant 10,000,000$ Accumulated Depreciation -
Rate Base 10,000,000$ Rate-of-Return 11.25%
Return on Rate Base 1,125,000$ Operating Expenses 3,000,000 Income Taxes 350,000
Revenue Requirement 4,475,000$
Year 2
10,000,000$ (1,000,000)
9,000,000$ 11.25%
1,012,500$ 3,000,000
350,000
4,362,500$
Year 3
10,000,000$ (2,000,000)
8,000,000$ 11.25%
900,000$ 3,000,000
350,000
4,250,000$
RoR also means that over time, earnings will decrease as plant depreciates
Jurisdictional SeparationsJurisdictional Separations
Telephone carriers are regulated by both state & federal government State jurisdiction → local & state toll Federal jurisdiction → interstate toll
So rate base and revenue requirement must be divided into their respective jurisdictions
Separations or “cost” studies are performed to accomplish this task
SeparationsSeparations
Net Telephone Plant x Rate of Return
+ Operating Expenses
= Total Revenue Requirement
State & Local
Revenue Requireme
nt
Jurisdictional Separations
Interstate Revenue Requirem
ent
Part 36: Separations RulesPart 36: Separations Rules
Primary purpose of Part 36 is to assign “property costs, revenues, expenses, taxes and reserves between state and interstate jurisdictions”
Costs are categorized based on function and use of the related plant
Basic StudiesBasic Studies
Four basic studies are performed to determine the use of facilities: Traffic Study Commercial Office Study Central Office Equipment Study Cable & Wire Facility Study
Then costs (plant balances & expenses) are allocated to jurisdictions based on these usage factors
Cost RecoveryCost Recovery
Once the jurisdictional revenue requirements are determined, there is the issue of recovering the costs
Telephone companies have three revenue streams: Local service rates from end-users Access rates from long distance carriers
• Interstate and State access rates
Universal Service Funds from the Federal & state governments
Revenue SourcesRevenue Sources
State & Local
Revenue Requireme
nt
Jurisdictional Separations
Interstate Revenue Requirem
ent
Interstate
Access
NECA Pools
Intrastate
Access
USFLocal
Revenue
Total Revenue Requirement
Universal Service & RatesUniversal Service & Rates
All rates are influenced by universal service
Universal Service is a policy that states that all Americans have the right to quality telecommunications services at affordable rates
Because of universal service, local telephone service in urban areas subsidizes rural service
Cost Recovery (cont’d)Cost Recovery (cont’d)
Local Rates are set by State PUCAccess rates are determined by the
cost of providing toll services (access costs) Determined by cost study
Universal service funds make up most of the difference between the cost of providing local service and the local rate
Access RatesAccess Rates
Access costs vary for each telco Access cost ÷ Toll minutes
= Access rate
For ease of administration, the National Exchange Carrier Association (NECA) produces one tariff for a large number of telcos
Access: NECA PoolsAccess: NECA Pools
The telco charges the long distance company the tariff rate (the average access rate developed by NECA)
NECA pools the money and distributes it to the telco based on the telco’s individual costs Determined from the cost study
Universal Service FundsUniversal Service Funds
Universal service funds are government subsidies for local service in high cost area
The telco’s average cost per loop is calculated
[rate base + operating expenses] ÷ number of lines
and compared to the National Avg Cost per Loop (NACPL)
A percentage of the difference is received as a subsidy
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