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Response to Professor Hogendorn

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Released: July 25, 2013

ResponsetoProfessor Hogendorn

WeappreciatethecommentsandsuggestionsmadebyProfessorHogendorninhis
peerreviewofversion2oftheConnectAmericaCostModel(abbreviatedeitheras
CACMorCAM).1 Wearepleasedthatheacknowledgesthatthemodelhas"avastly
moreaccuratemethodofmeasuringcosts,usingbothmuchmoredetailatthe
engineeringlevelandafarmoreprecisemethodofmodelinggeographiclocations"
and"ismoreaccurateinitstreatmentoftheroadnetworkthananyothermodel[he
was] awareof".2Hehas manygoodcomments,andasheacknowledges,manyofhis
commentsrelatetodefaultinputassumptionsinthemodelatthetimeofhisreview,
asdiscussedinthemodeldocumentation.WenotethatthattheWireline
Competition Bureau (Bureau) hassoughtfurthercommentoninputvalues,andhas
notyetadoptedanyinputvaluesfortheCAM.

Background

TheCAM estimates,foreverycensusblock,the cost ofprovidingavoiceand
broadband-capablenetwork.Thatcostislevelized,thatis,isturnedintoaconstant
(orkindofaverage)monthlycostassociatedwithservingthecensusblockoverthe
network'sentirelife.3 Givencostsforeachblock,themodelcanbeusedtocalculate
support.4 Inparticular,afuture Bureauorderwilldeterminealower"benchmark"
thatidentifiesareasthatcouldbeeconomicallyviableabsentsubsidies ("the
fundingthreshold"),andanuppercostthresholdthatdelineates thosedeemedtobe
extremelyhighcost.Thetotalsubsidywillbeequaltothecostofsupplyingeligible
Censusblocksthataremoreexpensivetoservethanthefundingthreshold,butare
notmoreexpensivethantheextremelyhighcostthreshold.Thetotalbudgetfor
supportin pricecapareaswassetbytheCommissiontonotexceed$1.8billion.5
Thus, changesincostorsupportcalculationswillchangetheobligationsthat
carriershavetoaccepttoreceivefunding,butwill notchangethetotalamountof
funding.
Therearefour primarypointsofdiscussionfromthereviewthatweaddressat
lengthinthisresponse:(1)futurechangesinprofitabilityforserviceareascovered,

1 WhilethepeerreviewreferstoCACMthroughout,thisresponse,consistentwith
ConnectAmericaFundetal.,WCDocketNos.10-90,05-337,ReportandOrder,28
FCCRcd5301(WirelineComp.Bur.2013)(CAMPlatform Order), willrefertothe
modelasCAM.
2 LetterfromChristiaanHogendorn,AssociateProfessorofEconomics,Wesleyan
University,toJulieVeach,Chief,WirelineCompetitionBureau,FCC,at3(February
19,2013)(Hogendorn).
3 CAMPlatformOrder,28FCCRcdat5308,para.15.
4 SeeConnectAmericaFundetal., WCDocketNo.10-90etal.,ReportandOrderand
FurtherNoticeofProposedRulemaking,26FCCRcd17663,17715-16,paras.134-
35(2011) (USF/ICCTransformationOrder).
5 Seeid. at17764,17725-26, paras.25,158-159.
1

(2)theCAMtakerate,(3)pricing,and(4)theexclusionofvideorevenues. Wealso
brieflydiscussothercommentsattheendofthisresponse. Foreaseofreference,
ProfessorHogendorn'scommentsareprovidedinitalics,andwehave,asmuchas
possible,respondedtohiscommentsintheordertheyappearinhisreview.

Serviceareascovered

Onthedemandside,theCACMisusedprimarilyforthoseareaswhichdonothave
broadbandserviceaccordingtotheNationalBroadbandMap(NBM).... Forarunof

theCACM,[the] boundary[betweenunprofitableareasandareasinwhichatleasta
monopolistwouldbeviable]istakenasfixedbasedoncurrentinputsfromtheNBM.
ThisleadstoconcernthatsomeoftheareasmodeledbytheCACMwouldbecome
profitableinthefutureifdemandgrows....Ifinfactdemandisgrowingoverthetime

period,thenprivateinvestmentmightoccurevenwithoutConnectAmericafunding.6
ProfessorHogendornimplicitly appearstobeconcerned thatsupportamounts
derivedfrom themodelmightoverstatethesubsidy requiredinaterritorythatis
notpresentlycommerciallyviable,but willbecomesointhefuture (thoughof
coursethereverseisalsopossible).7
Censusblockscouldbecomemoreviableovertimeforavarietyofreasons:costs
couldfall,eitherfromfalling inputprices and/orrising productivityin
telecommunications;andrevenuescouldincrease,forexample,duetodemand
changesthatallowgreaterretailprices, orcauseashifttowardsserviceswith
highermargins, and/or duetoanincreaseinthenumberofsubscribinghouseholds.
Eachofthesepossiblechangesisdiscussedinturn,whichwillinformtheBureau's
analysisinadoptingthefinalcostmodel andfunding thresholds.Wenotethatthe
Bureauhassoughtcommentonwhatrevenueassumptionsareappropriatetoadopt
forthefinalmodel.8Inoneormore futureorders,theBureauexpectstofinalizethe
inputvaluesforthemodelandsetafundingthresholdthattakesintoaccount
reasonableestimatesofexpectedperlocationlevelizedrevenues.

6 Hogendornat4-5.
7 Inthequotedparagraph,ProfessorHogendornconcludes,"TheCACM
documentationthatIreviewedindicatesa20-yearlevelizedARPUandtake-rate,soit
doesnotaddressthisproblem.
"Levelizeddemandisdiscussedhere,butalsobelow
underthesectionstitled"Pricing"and"Takerate."Thetakerateisdiscussedinthe
"Takerate"section.Thesupportthresholdhasnotbeendecidedyet,andinany
event,isapolicydecisionnotsubjecttopeerreview.
8 LetterfromMichaelJ.Jacobs,LegalAdvisortotheChief,WirelineCompetition
Bureau,FCCtoMarleneH.Dortch,Secretary,FCC,WCDocketNo.10-90 &Attach.at
23-30(filedJune25,2013)(WCBJune25VirtualWorkshopSubmissionLetter),
availableat http://appsint.fcc.gov/ecfs/document/view?id=7520925138 and
http://appsint.fcc.gov/ecfs/document/view?id=7520925140.
2

Costscouldfall. Themodelassumesthatinputpricesremainfixed,andthereareno
productivityincreases.Inactuality,thesethingswilllikelychange,andinamanner
thatcouldleadtheCAM,forthoseareaswherethesubsidyislikelytoapply, toat
mostmildlyoverstatecosts. Ifitisassumedthat,consistentwiththeUSF/ICC
TransformationOrder, the costmodelisusedtodeterminesupportamountsfor
lineswithcoststhatliebelowthetopfirstpercentile,9 thenweestimatethat
subsidieswillapplytolineswithcoststhatliebelowthisupperthreshold,and
somewhereabovethe90th costpercentile.ThefollowingtabledividestheCAM's
costsintoten aggregatecategories,indicatingtheproportioneachrepresentsof
totalcostsforlinesinthe90th to99th costpercentiles. Italsoprovidesestimatesof
theaveragegrowthinthepricesofeach,andproductivitychanges.10Usingarange
ofextremevaluesfortheseforecasts,11 thetableshowsthatoverallcostsarelikely
tofallnomorethan2.1 percent,andcouldevenriseby1.6 percent. While the
midpointofthisrange,-0.25percent,isnegative,suggestingasmallexpectedcost
overstatement,givenforecasterrors,anynumberinthisrangeisessentially
indistinguishablefromzero.Additionally,otherfactorssuggesttheCAM
understatescosts,forexample,becausetheCAM optimizescostsatahighlevel,soin
generalwillnotaccountforspecialcircumstancesthatgenerallyworktoraisecosts,
andduetotheCAM'sassumptionsaboutretailpricesand possiblyalsoretailservice
quality,discussedbelow.
Annualprice
Reducecostsby:
change
Baseline
%of
Low
High
Low
High
Change:
Change:
($M)
total
estimate estimate
TFP*
TFP*
lowcost
highcost
growth
growth
estimate
estimate
Labor
$17,678 70.0%
0.9%
3.6%
0.1%
0.7%
$17,710
$18,301
Fiber
$918
3.6%
-5.0%
-5.0%
0.1%
0.7%
$865
$871
Poles
$497
2.0%
2.0%
2.0%
0.1%
0.7%
$503
$506
Conduit
$804
3.2%
0.0%
0.0%
0.1%
0.7%
$798
$803
Drop
$81
0.3%
-2.0%
-2.0%
0.1%
0.7%
$79
$80
ONT
$859
3.4%
-5.0%
-5.0%
0.1%
0.7%
$810
$816
Fiber
$442
1.8%
-5.0%
-5.0%
0.1%
0.7%
$417
$419
pedestals
Splitters
$1,589
6.3%
-5.0%
-5.0%
0.1%
0.7%
$1,499
$1,509
Electronics
$847
3.4%
-30.0%
-10.0%
0.1%
0.7%
$588
$762
Land/Bldgs
$1,526
6.0%
-5.1%
3.4%
0.1%
0.7%
$1,437
$1,577
Total
$25,240 100%
$24,706
$25,642

Percentchangefrombaseline:

-2.1%
1.6%

9 SeeUSF/ICCTransformationOrder,26FCCRcd at17837,para.533.
10 Thetable,itssources,andthecalculationsdiscussedhereareexplainedinmore
detailintheappendixtothisresponse.
11 Theuseofextremevaluesresultsinanimprobablerangeofpotentialprice
movements,sincethelowerboundoftherangeonlyoccursifallvariables
simultaneouslytakeonthevaluesthatwouldgivethesmallestcostincrease,and
similarlyfortheupperbound.
3

*TFPreferstototalfactorproductivity.IfTFP increases byonepercent,then,holdinginputprices
fixed,thesameoutputcouldbeproducedwithonepercent lessexpenseoninputs.
Totheextentthateitherthelowerand/ortheupperthresholdareraised,(i.e.,tothe
extentsupportisprovidedtolineswithcostsexceedingthetoponepercent),the
rangeoverwhichpricesarelikelytomoveisraised,loweringtheextenttowhich
theassumptionofzerocostchangespotentiallyunderstatescosts.12
Revenuescouldrise. Materialincreasesin retailpricesalsoseemtobeunlikely: for
example,inonestudy, medianpricesfrom2004to2009fellforstandalone cable
andDSLbroadbandservices forallreportedbandwidths,except oneinwhichthe
medianpricewas essentiallyunchanged.13 Totheextentthatsuchdeclinesinretail
pricesarenotconsideredinthesettingofthefundingbenchmarkusedtodetermine
subsidies,overtimethemodelwillincreasinglyunderstatethesubsidy necessary
forprofitablesupplyofservice.14Similarly,whileashifttowardhighermargin
servicescannotberuledout,historicallybroadbandserviceshaveseenasteady
increasein servicequality,suchasbandwidth growth, whilebandwidth-adjusted
prices havefallen.15Suchqualityincreasesarecostlytoprovide,butthesecosts, as
theymightbeincurredoverthelonglifeofafibernetworkmaynotbefully
accountedforinthemodel,againleadingtoanoffsetting(thoughpossiblysmall)
understatementofcosts.Populationgrowthinruralareasisnotlikelytobelarge,16
soisunlikelytoleadtoamaterialincreaseinrevenues.17

12 Forexample,iflineswithcostsinthe95th to99th percentilesareconsidered,the
potentialrangeofcostvariationrunsfrom-1.9%to+1.8%(incomparison,looking
attotalcostsgivesacostvariationof-3.5%to+0.8%).Thisvariationoccurs
becauselaboristhemajorcostassociatedwithlooplengths andlooplengthsgreatly
increaseinhighercostareas.Thedataunderlyingthesecalculationsandfurther
explanationispresentedtheappendixtothisresponse.
13 ShaneGreensteinandRyanMcDevitt,EvidenceofaModestPriceDeclineinUS
BroadbandServices,28Info.Econ.andPolicy 200,206figs. 2 & 3 (2011),availableat
http://www.sciencedirect.com/science/journal/01676245/23/2.Whilereported
meanpricesacross bandwidthsbothroseandfell,theannualaveragerateof
increaseinthemeanstandalonecablepricewasonepercent,andthemean
standaloneDSLrateessentiallyreturnedtoits2004value.Id. at206,208&207tbl.
3.
14 Subscriptionrates, andotherassumptionsnecessarytodeterminelevelized
revenue, willbemadeinaforthcomingBureauOrder,aswillbetheassumptions
necessarytodeterminethebenchmarkandtheupperthreshold.
15 Id.Thepaperestimatesthat,takingaccountofimprovementsinbandwidth,
pricesdeclinedbetween3and10percentfrom2004to2009.Thisdoesnotimply
thatrevenuesnecessarilyfell,sincetheaveragepriceperservicenotadjustedfor
bandwidth couldhaverisen.
16 AnnualruralpopulationgrowthintheU.Shasprobablysteadilydeclinedsince
2005-2006,from0.74%to0.11%in2010-2011(ahiccupin2009-2010ispartly
4

Moreover,totheextentthefundingthresholdultimatelyselectedbytheBureau
underestimatesthepotentialforprofit,themodel-based subsidiesonlywillbe
available forfiveyears forthecarriersthatelecttomakeastate-levelcommitment.
Accordingly,evenifoverthecourseofthattimeperiodsomeofthepresently
unservedareasweretobecomemateriallyprofitable,thiswouldnotlikelybethe
caseformostgeographiesintherelevanttimeframe forthosecarrierselectingto
receivemodel-basedsupport,andthecompetitiveprocessenvisionedbythe
Commissionattheendofthefiveyearscouldprovideanotheropportunitytore-size
thesubsidy.Consequently,carriersareunlikelytobeabletoreceivesubsidiesin
locationstheywouldhaveenteredanyway.18

TakeRate

Thedefaulttake-rateintheCACMis90%,whichseemstoohigh.19
ProfessorHogendorn'scommentregardingtheCAM'sdefaulttakerateof90
percentatthetimeheconductedhisreviewappearstofocusonwhetherthisisan
appropriateassumptionregardingsubscriptionlevels.Attheoutset,wenote that
theBureauhasadjustedthedefaulttakerateinthecurrentversionofthemodeltoa
lowerfigureandhassoughtcommentontheappropriatetakeratetouseinthe
model.20TheBureauwillfinalizetheCAMtakerateinafutureorder.
ThepurposeoftheCAMtakerateistodeterminethenumberoflocationsthatare
actuallyconnectedtothenetworkbyadropandopticalnetworkterminator(as
opposedtojustbeingpassedbythenetwork).TheCAMtakeratenecessarilymust
behigherthancurrentorevenexpectedsubscribershiprates foratleasttwo
reasons.21First,atanypointintimesomelocationswillbevacant,ortheoccupiers
willnotpresentlywishtopurchasebroadbandservice,butthiswillchangeover

explainedbyadjustmentstocountypopulationestimatesfollowingthe2010
Census).See Econ.ResearchServ.,U.S.Dept.ofAgric.(USDA),"RuralAmericaata
glance:2012edition,"pp.5-6,availableat
http://www.ers.usda.gov/media/965908/eb-21_single_pages.pdf (lastvisitedJune
24,2013).
17 ProfessorHogendornalsoexpressesconcernthattheCommission'sestimateof
levelizeddemandmaybetoolow,onwhich,see thediscussionunder"The
subscriptionrate"below.
18 Modelsupportalsogivesprovidersanincentivetomaximizesubscriptions,since
theamountprovidedisfixed,whileeachnewsubscriberbringssubstantial
revenues,withoutrequiringadditionalnetworkdeployment.
19 Hogendornat5.
20 See WCBFeb.6,2013VirtualWorkshopSubmissionLetter,Attach.at39-40.
21 See LetterfromMichaelJ.Jacobs,LegalAdvisortotheChief,WirelineCompetition
Bureau,toMarleneDortch,Secretary,FCC,WCDocketNo.10-90,Attach.at39-40
(filedFeb.6,2013)(WCBFeb.6,2013VirtualWorkshopSubmissionLetter).
5

time.Such"churn"meansthatatanypointintimethepercentoflocationsthat
havelastmilefacilitiesalwaysexceedsthesubscriptionrate.Second,becauseofthe
precedingpoint,andtotheextentthatsubscriptiongrowthisexpectedovertime,it
isreasonabletoassumethatitisefficienttodeploytomorelocationsthanthose
withcurrentsubscribers(forexample,becauseitisoftencheapertodeploytoall
locationsinastreet,thantoextendservicepiecemealtoeachlocationasdemand
requires).22

Pricing

TheCACMdefaultARPU[averagerevenueperunit]inputsare"typical"pricesfor
broadbandinAmerica.Buttheareasbeingdealtwithwillonlyhaveoneprovider
whereasthe"typical"areahasfacilities-basedcompetition. Economictheorywould

predictthatamonopolyareawouldhavehigherprices,andthushigherARPUand
lowertakerate,thananareawithcompetition.Itmaybethattheserviceproviders
receivingConnectAmericafundingareundereitherexplicitregulationorimplicit
regulatorypressuretochargethesamepricesasinareaswithcompetition. Oritmay

bethatmanyoftheseserviceprovidersalsoserveareaswherethereiscompetition
andneedtomaintainuniformpricingeitherformarketingpurposesortoavoid
angeringcustomers. Butwhateverthereasons,whenthemodelisusedtheissueof
monopolymarketstructureshouldbeaddressed.Thereshouldbeanexplicit
justificationforwhyamonopolywouldchargeanythingotherthantheprofit-

maximizingmonopolyprice.23
TheTelecommunicationsActof1996establishestheoverarchingprinciplethat
consumersinallareasofthecountryshouldhaveaccesstoservicesthatare
reasonablycomparabletothoseinurbanareas"atratesthatarereasonably
comparabletorateschargedforsimilarservicesinurbanareas."24Itthereforeis
appropriateforthemodeltoassume anaveragerevenueperlocation whichisnot
significantlyhigherthanthoseachievableinareaswithcompetition.
TheBureauhassoughtcommentonwhatrevenueassumptionsareappropriateto
adoptforthefinalmodel.25Inoneormore futureorders,theBureauexpectsto

22 Theseassumptionsproducetwoeffects.Ontheonehand,theCAMassumesthe
networkisoptimallybuiltoutatonce,when,forexample,networkdropsarenot
alwaysdeployedoptimally fromanexante perspective,butratherarebuilt
piecemeal,followingdemand.ThisleadstheCAMtounderstatecosts.Ontheother
hand,wheredelayisoptimal,asmightbethecaseforthosedropsthatareonly
requiredatalaterdate,theCAMwilloverstatecostsbecauseitdoesnotoptimally
postponesuchexpenses.Thesavingsduetodelayrisewithfuturegrowth,and
especiallytotheextenttowhichthatgrowthisback-loaded(whichdoesnotseem
likely).Itisnotobviousthatoneofthesetwoeffectsdominatestheother.
23 Hogendornat4.
24 47U.S.C.245(b).
25 WCBJune25VirtualWorkshopSubmissionLetter.
6

finalizetheinputvaluesforthemodelandsetafundingthresholdthattakesinto
accountreasonableestimatesofexpectedperlocationlevelizedrevenues.

Theexclusionofvideorevenues

TheCAF2 modeloverviewexplicitlystatesthatvideoequipmentisnotincludedinthe
CACM.ThisseemsentirelyappropriatesincethefundingisforInternetnotvideo.On
theotherhand,ARPUalsoexcludesvideo,eventhoughmostofthecostsofthevideo
willbeattributabletothesamefacilitiesasthebroadbandInternet.Thereshouldbea

videoARPUassumptiontohelpoffsetthecostsofthesesharedfacilities. ...26
ProfessorHogendornappearstosuggestthatvideorevenuesmaynotbe
appropriatelyaccountedforindeterminingtheefficientsubsidy.Attheoutset,we
notethattheBureauhasnotyetmadeadeterminationofwhattypesofrevenues
shouldbeassumedwhendeterminingthefundingthreshold.Thedecisionof
whethertoassumevideorevenuesindeterminingthesupportthresholdisapolicy
decisionnotsubjecttopeerreview.
Moreover,evenifvideorevenuesarerelevant,theywouldonlybesototheextent
thattheyexceedtheincrementalcostofvideoprovision,andhencecontribute
towardsharedcosts.Itispossiblethatthecontributionfromvideoserviceswould
berelativelysmall,andthereforeunlikelytodistorttheCAMsubsidyestimates.27
Beinglateentrants,incumbentlocalexchangecarriers(ILECs) havearelatively
smallshareofallvideosubscribers.28Becauseoftheirvideomarketshare,ILECs
typicallyfacehigherpersubscriberprogramming, consumerpremiseequipment,
andcustomeracquisition coststhantheircableand satelliterivals,29 reducingtheir

26 Hogendornat7.
27 ThechoicetomodelaFTTPnetwork,withorwithoutvideorevenues,doesnot
implycarriersacceptingmodelsubsidiesmustdeployanFTTPnetworkandoffer
(ornotoffer)videoservices.
28 Thecombinedsharesofalltelephonemultichannelvideodistributors(MVPDs)
accountedforapproximately8.4 percentofMVPDsubscribersattheendof2011,
comparedto6.9percentattheendof2010..Thelargestofthese,Verizon,wasthe
7th largestMVPD,whilethe2nd largest,AT&T,wasthe9th largest.AnnualAssessment
oftheStatusofCompetitionintheMarketfortheDeliveryofVideoProgramming, MB
DocketNo.12-203,FifteenthReport, FCC 13-99at12-13,paras.28,30(rel.July22,
2013)(15th VideoCompetitionReport).Accordingtooneanalyst,asofMarch2013,
telephoneMVPDsharehadrisentoclosertotenpercentofthemarket(Leichtman
ResearchGroup,pressrelease,May20,2013,
http://leichtmanresearch.com/press/052013release.html,viewedMay 31,2013).
29 15th VideoCompetitionReport,FCC13-99at34-35,paras.69-72.SNLKagan
reportsthatlargerMVPDsfacelowerprogrammingcosts.SeeTelcoTVOutlook:
CompetitiveanalysisofUStelcovideodeployments,2007edition,SNLKagan,June
2007("volumediscountsandmost-favored-nation(MFN)clausesensuring
multichannelgiantssuchasComcastandTimeWarnerCablealwayspayrates [for
7

pervideosubscriber margins. Infact,thepervideosubscribercontributionfrom
videocould benegative,buttheoperatormightstillprovidetheservicebecauseit
preventsfurtherlossofvoicecustomerstomobileandotherrivals.30Thefailureto
includeanetcontributionfromvideothereforemaybeunlikelytoleadtoan
overstatementofthenecessarysubsidyrequiredforavoiceandbroadband-capable
broadbandnetwork.

OtherMatters

Terminalvalue(oroperatingprofit).Professor Hogendornstates thattheCAM"does
notincludeanyterminalvalueattheendofthe20yearperiod."31Thedecisionof
terminalvalueinthemodelisapolicydecisionnotsubjecttopeerreview.Wedo
note,however,theCAM doeseffectivelyincludeaterminalvalue.Itmodelscosts,
andhencealsotheimpactofthefundingthreshold, sufficientlyfarintothefuture
thatthepresentvalues of futurecostsandrevenuesapproachzero.
Technologychoices or"roadmapping".Professor Hogendornnotesinpassingthat
theversionofthemodelheexaminedincludedbothDSLandfiber-to-the-premise
(FTTP)options,andhesuggestsexploringtheFTTPoptionmoreextensively.The
decisionofwhatnetworkarchitecturetomodelisapolicydecisionnotsubjectto
peerreview.WenotethattheCAMPlatform Order adoptedan FTTPapproach,
consistentwithProfessorHogendorn'spreference.32
Brown-fieldvs.Green-fieldApproach.ProfessorHogendorncommentsinpassingthe
green-fieldoptionis"useful...forconsideringthepossibilityofcompetitiveentry,"
buthewas"notsurewhythegreen-fieldoptionwouldeverbeapplicableunless
thereareinstanceswherethereistrulynoinfrastructureinaparticularservice
area."33Thedecisiontoadoptagreen-fieldoverabrownfieldapproachisapolicy
decisionnotsubjecttopeerreview.34
Voice.ProfessorHogendornappearstobeconcernedthatthemodeloverstatesthe
operatingcostsassociatedwithbroadbandservicedeliveredoverfacilitiesshared
withvoiceservice.TheCommissionhasdetermined,however,thattheBureau
shouldmodelthecostofanetworkcapableofprovidingbothvoiceandbroadband

programming] lessthanorequaltothosechargedtheircompetitors. ... wepolled
somesmalloperatorsandfoundtheywerepayingabout30%morethanthe
averageforadozennetworksrandomlychosenforoursurvey.").
30 Forexample,thiswouldbetrueifpackagingvideowithvoice(andperhaps
broadband)makes,holdingotherthingsconstant,customerslesslikelytoswitch
theirvoiceservicestoanotherprovider.
31 Hogendornat6.
32 CAMPlatform Order, 28FCCRcdat5314-16,para. 33.
33 Hogendornat7.
34 SeeCAMPlatform Order, 28FCCRcd at5309-14,paras. 19-32.
8

services.Itthereforeisappropriateasapolicymattertoincludeallvoiceoperating
costs,aswellasbroadbandoperatingcosts.Further,theCAMdoesnotdoublecount
costssharedbetweenvoiceandbroadbandservices.
Buildingaheadofdemand.ProfessorHogendornobserves,"Inanenvironment
wheredemandisgrowing,serviceprovidersmayanticipatethegrowthandprepare
foritinastrategicway.... Thepreemptionlogicsuggeststhatiftherewillbeany
increaseindemandthatmakesanareaviable,thenaserviceprovidermayenter
thatareawhilean`investmentgap' stillexistsbecauseitanticipatesfutureprofits.
TheCACMiswell-placedtotest this.IftheCACMshowsthatareasthatalreadyhave
servicehaveagaptoprofitability,thenitispossiblethatfirmshavebuiltaheadof
demandinordertoachievefirst-moverstatus.Sincetheareasunderevaluationare
verylowdensity,Iwouldexpectthatanypreemptiveinvestmentwouldcomefrom
theexistingtelcotryingtobeattomarketapotentialfixedwirelesscompetitor."35
WeappreciateProfessorHogendornsharinghisthoughtsregardingpotential
preemptiveentry.Wenotethatinsomeinstances,entryintootherwise
unprofitableareasmayhaveoccurredbecauseofpastsubsidies,orbecauseofother
regulatorymandates,suchasstaterequirements.Inshort,regulationmayexplain
supplyinunprofitablelocations,ratherthantheoperator'slong-termviewthatthe
locationisprofitable.Inaddition,demandforbroadbandinthoseareascouldbe
strongerthanaverage(e.g.,duetodifferencesinconsumerdemographics,whichis
notcapturedintheCAM),leadingtoastrongerbusinesscase(justasinother
locationsitmaybeweakerthanaverage).Asisthecasewithanymodel,itisalso
possiblethattheCAMoverstatescostsinsomeareas(justasitlikelyunderstates
costsinotherareas).Thus,theobservationthatsupplysometimesoccursinareas
thecostmodelfindstobeunprofitableisinsufficienttodemonstratethatthe
networkoperatorexpectsthat(absentregulatoryaction)theareaswilleventually
beprofitable.

35 Hogendornat5.
9

Appendix

TheCAM'ssensitivitytoinputpriceandproductivitychanges

Thisappendixtestshowsensitive theCAM'scostsaretochangesin forecastsin
inputpricesandtotalfactorproductivity(TFP)growth. ItfirstpresentshowCAM
costsaresharedacrossten costcategoriesforthreecases: alllines; linesthatlie
withinthe90thto99thcostpercentiles;and linesthatliewithinthe95thto99th
percentiles.Itthenprovidestheassumptions oninputpriceschangesfortheten
costcategories,andtotalfactorproductivity(TFP)growth,usedinthesensitivity
tests.Finally,itshowsthatundertheseassumptions,whicharedesignedto
understateCAMcostgrowth,overall annualchangestocosts forhighcostareasare
unlikely tosignificantly differfromzero. Thus,theCAM'sassumptionofzero
changesincostsisunlikelytosignificantlyoverstatecosts,andmaywellunderstate
them.

Costcategoriesandshares

Thefollowingtableprovidesthecostsharesforthetenbasiccostcategoriesofthe
CAM,ineachofthreecases:foralllines,forlineswithinthe90th to99th cost
percentiles,andforlineswithinthe95th to99th costpercentiles.Thetable
illustratesthatthecostsharesofespeciallylabor,butalsofiber,poles,conduit,and
splittersriseasthefocusnarrowstowardhighercostlines.Thisisduetoincreased
looplengths,ofwhichassociatedlaborcostsareasignificantcomponent.In
contrast,thecostshareoftheothercomponentsfall.
Costcategories
Alllines
Lineswithinthe
Lineswithinthe
90th to99th cost
95th to99th cost
percentiles
percentiles
Labor
59.6%
70.0%
71.3%
Fiber
2.9%
3.6%
3.6%
Poles
1.2%
2.0%
2.0%
Conduit
2.2%
3.2%
3.4%
Drop
1.4%
0.3%
0.3%
ONT
9.1%
3.4%
2.9%
Fiberpedestals
2.7%
1.8%
1.6%
Splitters*
5.7%
6.3%
6.5%
Electronics
6.4%
3.4%
3.1%
Land/Buildings
8.7%
6.0%
5.3%
Total
100.0%
100.0%
100.0%
*Approximately30%ofthiscategoryisfiber,butthetwoexpensesarenoteasilyseparated.
Individualcomponentsmay notsumto100percentduetorounding.

Source

:CAM (version3.1)

Averageannualchangeinlabor costs

10

Limitedinformationwasavailabletousoncostmovementfortheten cost
categoriesjustoutlined.Thefollowingtableillustratesthathistorically, laborcosts
intelecommunicationshavetendedtoexperiencelowpositiveannualgrowth,and
togrowatlowerrates thanthenationalaverage.Thedata comefromtheBureauof
LaborStatistics' OccupationalEmploymentStatistics,whereweusedaverage
annualwagesfortheprivatesectorasawholeandthetelecommunicationsindustry
inparticular,for2002to2012.Inoursensitivityanalysis, weusedtheaveragefive
andtenyearannualizedratesofchangeintelecommunicationslaborcosts.

Averageannualchangeinlaborcosts

Averageannualchangeinfiber,poles,conduit, drop,ONT,fiberpedestal,

splitters,andelectronics
Wedonothavegooddatasourcesforthehistoryofpricechangesforthefollowing
inputs: fiber,poles,conduit,drop,ONT,fiberpedestal,splitters, andelectronics.
However,theCAM'soverallcostchangesarenotparticularlysensitivetothe
individualcostofanyofthese.Forthe90th to99th costpercentiles,thecostshare
foreach,exceptingsplitters, doesnotexceed 4percent (thecostshareofsplittersis
6.3 percent).
Webelievethat fiberprices rarelydeclinefasterthananannualizedrateof5
percent,andso,leaningtowardunderstatementofcostgrowth,weusea5percent
declineinfiberpricesinoursensitivitytests.USAC'scostmodelingcontractor
(CostQuest)estimatedanannualtwopercentdeclineinfibercostsbasedonworkit
doesforitsprivate-sectorclients.
Weassumethefollowingannualpricechanges:forpoles, 2percent;conduit,no
change;dropcosts, -2percent; andONT,fiberpedestalsandsplitters,all-5percent.
TheseestimatesofpricechangesalsocomefromCostQuest.
Webelieveelectroniccostslikelyfallbyamaterialamountovertime,butdonot
havedataappropriatetothiscostcategory.Accordingly,againleaningtoward
understatementofcostgrowth,inour sensitivitytestsweapplyarangeofannual
costdeclinesof-30to-10 percenttoelectronics.Webelievethatthisrangeislikely
tounderestimatetheactualreasonablerangeofpricemovementsinelectronics.36

36 Forexample,itisestimatedthattheaverageannualquality-adjustedpricechange
from1995to1999forrouterswas-14%,forswitches,-22%,forLANcards,-18%,
andforhubs,-19%(PricesforLocalAreaNetworkEquipment,MarkDomsand
11

Averageannualchangeinpropertycosts

Wedonothaveapriceseriesthatcouldbeassociatedwiththecostoflandand
buildingsusedinnetworkdeployment.Asapotentialindicatorofpricechangesfor
thiscategory,thefollowingtablelistschangesinthepriceofcertainkindsof
commercialproperty.Thedata comefromtheMoody's/RCACPPIReportfromApril
9,2013.We usedtheMaypriceindexforallcommercial(National),industrial,and
corecommercialrealestatefor2002to2012.Inoursensitivityanalysisweapply
thelowestandhighestratesofchangelistedinthetable.

TFP growth

WedonothaveanyestimatesforTFPgrowthintelecommunications.Thefollowing
tableprovidesTFPestimatesfortheU.S.economyasawhole.The"TFP-utilization"
columnproducesgainsinproductivitythatreflectcapacityutilization.The
estimatescomefromtheFederalReserveBankofSanFrancisco'sCenterforthe
StudyofIncomeandProductivity,anddatafor2012wasnotyetavailablewhenwe
accessed thesource.Again,inoursensitivityanalysisweapplythelowestand
highestratesofchangelistedinthetable.

Sensitivitytesting

UsingtheinputpriceandTFPgrowthassumptionsjustdescribed,wetestedthe
sensitivityofeachofthethreecasesoutlined abovetoinputpriceandTFPchanges:
alllines,linesinthe90th to99th costpercentile,andlinesin95th to99th cost
percentile.Ourresultsarereportedintablebelow.Theseresultsarenotsensitive
tosmallchangesintheinputpricechangesforanyofthecostcategories,orinthe
TFPgrowthestimates.

Scenarioanalysis

Assumedannualchangeinprice


ChrisForman,June2003,pp.17-20,
http://www.frbsf.org/publications/economics/papers/2003/wp03-13bk.pdf,
(viewedMay31,2013).
12

Costcategories

Lowestimate

Highestimate

Labor
0.9%
3.6%
Fiber
-5.0%
-5.0%
Poles
2.0%
2.0%
Conduit
0.0%
0.0%
Drop
-2.0%
-2.0%
ONT
-5.0%
-5.0%
Fiberpedestals
-5.0%
-5.0%
Splitter
-5.0%
-5.0%
Electronics*
-30.0%
-10.0%
Land/Buildings
3.4%
-5.1%

AssumedannualTFPgrowth

Lowestimate

Highestimate

TFPgrowth

0.1%
0.7%

Resultingcostrange

Annualnetimpactoncosts

Lowestimate

Highestimate

Totalcosts
-3.5%
0.8%
90th to99th costpercentiles
-2.1%
1.6%
95th to99th costpercentiles
-1.9%
1.8%
*IncludesFTTPinputsuchasONT,butnotfiber.
Whilenofinaldecisionhasbeenmadeonfundingthresholds,giventhefixedbudget
ofupto$1.8billioninfundingforpricecapterritories,andtheCommission's
expectationthat nomorethan1percentoflocationswouldbeabovetheextremely
high-cost threshold,37 thefundingthresholdislikelytobewellabovethe90th cost
percentile. Accordingly,theannualcostchangerangeestimatedforthe90thto99th
costpercentiles(-2.1 percentto1.6 percent)maybe skewedlower thanwouldbe
thecaseforthefundingthresholdultimatelyselected.Moreover,whilethe
midpointoftheannualcostchangerangeisnegative,theunderlyingassumptions
usedtoderiveitlikelymeantheexpectednetchangecouldbehigherthanthis.This
isalsotruefortheannualcostchangerangeestimatedforthe95th to99th cost
percentiles,-1.9to1.8 percent,withamid-pointthatisevenclosertozero and
positive.
Given theuncertaintyinherentinthesekindsofforecasts, littleweightshouldbe
attachedtoapointestimate.Instead,therangeindicateswhiletheremaybea
somewhathigherprobabilitythatthenetannualchangeintelecommunications
costsaccountingforproductivitygainsisnegative,whateverthechangeis,itisalso
likelytobesmall,anditcouldbepositive. Thisanalysisalsoshowsthatthis

37 SeeUSF/ICCTransformationOrder,26FCCRcd at17837,para.533.
13

outcomeisnotsensitivetodifferentchoicesamongthesubsidizedhighcost
percentiles.
14

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