Telecommunications in the State of Maryland:

Regulation and Competition

By Mark Katsouros and Clay Gump

December 2, 1996

What type of Regulation does Maryland impose on the local telephone company?

Maryland's telephone companies, like most utilities, traditionally practiced rate base/rate of return regulation, which typically resulted in over-investment in capital and lack of productivity improvement. Over-investment in capital was due to the fact that profits could only be earned on capital investments. Likewise, no incentive to invest in productivity improvement existed since any and all resulting cost savings were passed on directly to customers. So, in hopes of paving the way for alternative regulation which would give phone companies greater incentive to invest in, and hence improve, productivity, the General Assembly enacted Chapters 140 and 141, during the 1995 legislative session. These added Section 69(e) to The Public Service Commission ("PSC") Law, which granted the Commission authority to regulate phone companies by other means.

Still a requirement, of course, was that any newly adopted regulatory form must provide price and service quality protection for customers, encourage the development of competition, and be in the public interest.

Subsequently, alternative regulatory proposals were filed by MCI, Bell Atlantic-Maryland, Inc. ("BA-MD"), and OPC, on November 20, 1995, December 22, 1995, and January 23, 1996, respectively. On January 19, 1996, the PSC officially filed its price cap proposal. Additionally, many companies (AT&T, Sprint, and so on) were granted petitions to intervene. Proceedings were instituted in order to examine each proposal, as well as review BA-MD's rates as necessary to meet the requirements of the aforementioned Section 69(e). Evidentiary hearings were held from April 15, 1996 through April 19, 1996, and completed on April 22, 1996.

All four proposals involved alternative regulatory plans that would regulate BA-MD's prices rather than its earnings, with MCI's being the most streamlined in that it proposed there be no auto price adjustments and no competitive safeguards, but instead rely on the strict enforcement of anti-trust laws. Noteworthy are the facts that the PSC's plan recommended a service quality index offset as a mechanism to allow for the reduction of BA-MD's price cap index if BA-MD fails to meet proposed service quality requirements, and that OPC's plan required the price for each service used by BA-MD to exceed its long run incremental cost and the price for each rate element to exceed its long run marginal cost. As the parties addressed the various issues, their, albeit predictable, positions became clear. BA-MD claimed that the penetration rate having increased to 97.3 percent demonstrates that rates are affordable and reasonably priced. OPC stated that BA-MD's plan provides too much relief from oversight and regulation, while impeding the emergence of full and fair competition, and that MCI has presented a price cap plan that primarily protects its corporate interests.

Each party, of course, presented reasons as to why their plan is best. The PSC argued that "reasonably priced basic local exchange service" means it is priced close to cost, so their plan will respond directly to the legislative mandate. MCI remained firm in its point that basically competition will drive down prices which is best for customers. With regards to the inflation offset/productivity factor, BA-MD interestingly contended that productivity gains have already been realized, while OPC contended that its proposed 5 percent inflation offset would result in lower prices to customers for increases in productivity. OPC asserted that telecommunications is a declining cost industry, and that BA-MD is experiencing explosive growth. The PSC conducted a complete Total Factor Productivity and Input Price Differential analysis to confirm that the telecommunications costs are indeed declining.

Also addressed were the criteria used in grouping services, especially what standards the PSC should use to determine if a new service can be placed in the "competitive basket" thereby avoiding being subject to any pricing limitations. BA-MD proposed that the PSC rely on existing standards as supplemented by an objective test for showing that standards have been met, while practically all other vendors suggested that competitiveness should be gauged via a market power analysis. Taking market share and concentration into account, the PSC proposed (with Sprint's support) using the Department of Justice criteria for measuring the competitiveness of service offerings, which incorporates both a market power and a market share test, as well as the Herfendahl-Hirschman Index.

Access rates and universal service mechanisms were also addressed, primarily for the purpose of promoting competition. Both are discussed in the competition section of this paper.

Finally, after much consideration of the proposed plans and the proceedings in general, the PSC adopted a price cap plan which it "crafted" from the record of the proceedings. The plan provides for grouping services in baskets, allows pricing flexibility among services within baskets but not between baskets, caps and freezes rates for the services contained within certain baskets, and requires BA-MD to continue filing tariffs.

Additionally, mechanisms were established to detect and rectify inadequate service, access charges were reduced, and safeguards were established to ensure that captive customers will not subsidize BA-MD's competitive service offerings and that competitive services are not offered at unfair prices.

By grouping services into baskets, the PSC will be able to impose a higher degree of protection on the services that require it, while permitting BA-MD the flexibility to respond to the market and the specific needs of some customers in the market segments where competition is an effective regulator of corporate behavior. Within each basket are services which are homogenous in terms of demand elasticity and competitive alternatives, which essentially means that BA-MD's only incentive to adjust price should be market conditions. And since rate adjustments between services located in different baskets is prohibited, cross-subsidization of services by monopoly services is not possible.

As agreed upon by all parties who proposed a price cap index, the Gross Domestic Product-Price Index is the appropriate index to represent the effect of production cost inflation, and was officially accepted by the PSC. However, since opinions varied greatly as to what the productivity factor, which will serve to offset the rate of inflation, should be, the PSC found that the Consumer Price Index ("CPI") constitutes a reasonable proxy for expected productivity gains. The PSC noted parenthetically that use of the CPI as a productivity offset has, in the recent past, provided a result very similar to 2.76 percent, which is the average of the inflation offsets used in 13 other states. To offset swings in the CPI, a three-year running average will be employed. Finally, a third and final component of the indexing mechanism is the exogenous costs change factor, commonly referred to as the "Z factor". This is in recognition that unpredictable external factors, which are out of BA-MD's control and do not affect the entire economy, may arise. The FCC determined that this can include costs triggered by administrative, legislative, or judicial actions that are beyond the control of BA-MD. BA-MD and others can propose what may be considered as Z factor costs., but the PSC makes the final ruling.

With regards to competitive safeguards, for BA-MD to categorize any service as competitive, it must show that the following conditions exist:

  1. entry is unimpeded by technical or legal restraints;
  2. there are competitors for the services;
  3. there are substitutes.

Furthermore, as requested by AT&T, BA-MD must provide the following additional information to the PSC when requesting reclassification of services in Baskets 1, 2, 3, and 4 (non-competitive) :

  1. breadth of market;
  2. market share characteristics of BA-MD;
  3. evidence of ease of entry and exit;
  4. factors on the ability of entrant to expand;
  5. factors on the willingness to switch providers;
  6. the price elasticity of demand;
  7. market data on percent of customers for whom choices are available and the percent who have availed themselves of choice.

A market may be defined as the entire state, a particular geographic area, or a particular subset of customers.

In addition to Maryland, the following states have adopted some alternative form of regulation for their dominant local exchange telecommunications companies: Alabama, Delaware, Florida, Georgia, Illinois, Indiana, Kentucky, Maine, Massachusetts, Michigan, Mississippi, New Jersey, New York, Ohio, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Virginia, Wisconsin, Wyoming, and Washington, D.C.

Is there competition at the local level?

The question addressed in this section of the paper is as follows. Does the Maryland Public Service Commission "PSC" allow competition for local service with the incumbent Local service provider?

The short answer is yes. Actually, Maryland has been one of the more vigorous states in implementing local competition. On July 26, 1993, MFS Intelenet of Maryland, Inc. filed an application with the PSC to provide and resell local and intrastate exchange services in the Maryland area. Of course this area was already served by the regulated RBOC Bell Atlantic of Maryland. The PSC concluded that this case would establish general policies and procedures for telecommunication carriers seeking to enter the local Maryland market.

After holding evidentiary hearings, the Commission granted the application of MFS in order No. 71155 issued on April 25, 1994 (85 Md PSC 38).

Bell Atlantic, being the monopoly in Maryland, of course had many reservations about opening up its market to competition. And since this was before the Telecommunication Act of 1996 passed by congress, the Maryland PSC was under no legal constraint to establish local competition. Shooting down the classic argument made by AT&T before divestiture, the PSC decided that the purchase of unbundled elements, which is what competing local companies would need, is "reasonable and technically feasible without causing damage to network integrity". In this case and in other documents since, (Case No. 8587, 8584, 8715) the PSC has continually concluded that permitting new entrants into the local telecommunication market is in the public interest. The arguments they have made are listed as follows. Expanded competition will…

The resulting regulations imposed as a result of MFS's application are described in Order No. 71155. The PSC established an interconnection charge of 6.1 cents for each call handed over to Bell Atlantic for completion. Also, the Commission directed BA to provide flexible direct-inward-dialing to co-carriers. This was to enable users to keep their number should they switch to another local provider.

This order from the PSC opened the door to local competition in Maryland. In the following months, other companies such as MCI Metro Access Transmission Services, TCG America, and SBC Media Ventures Inc. (the cable TV provider for Montgomery county) all submitted applications to provide local service.

The Maryland PSC order directed MFS and Bell Atlantic to meet together to resolve other technical and operational issues. Also, the Telecommunications Act of 1996 (Section 252) requires Bell Atlantic to negotiate agreements with the Competitive Local Exchange Companies "CLEC's" regarding interconnection. Of course the companies where unsuccessful in negotiations and eventually arbitration proceedings held by the PSC (as specified by the Telecomm Act of 1996) were required. On November 8, 1996, the PSC released Order No. 73010 which resolves these issues. On the same day, the PSC released Order No. 73011. Although this order mostly pertains to alternative forms of regulation, it also addresses some concerns with competition.

In the aforementioned decision, the PSC orders that access rates be reduced by $32,118,272 annually. This is broken up between a reduction in the local switching charge from $.012559 to $.003 and a reduction in the RIC from $.008094 to $.0060705. The $32 million is derived based on last years usage. Inter-exchange carriers and CLEC's are required to pass through the savings in access to reduce intrastate toll rates.

Therese Czarski, an assistant for OPC, states in The Washington Post that the PSC has done a grave injustice by ordering only a $32 million reduction. They were looking for more like $218 million per year. Also, she argues that the poor will not see the benefit of this reduction because they don't normally make long distance calls.

The costs that CLEC's should pay for universal service is still open for debate. In discussion on alternate forms of regulation, some of the participating companies put forth their views on what would be an appropriate charge for universal service. AT&T and the OPC take the position that universal service is already compensated by basic service charges. MCI estimates the level of support required to Bell Atlantic to be $13,322,000 annually which should be paid by the inter-exchange carriers. They go on to state that if access charges are lowered to cost then the table would be set for real competition and universal service will not be threatened.

Bell Atlantic, of course, disagrees with both arguments blaming flaws in the analysis used to determine the costs and revenues associated with providing residential service. According to Chrys Wilson from the PSC, the commission is still debating this issue.

There are many other issues that were resolved with PSC order No. 73010. A listing of some of the more pertinent are as follows.

First, the PSC agreed with Bell Atlantic's pricing structure for unbundled loops which uses density zones to determine price. Urban areas are charged $11.87 while the highest cost rural zone would be $19.38. As a comparison, MFS Inc. proposed charges ranging from $7.80 to $20.25.

CLEC's are forced to unbundle their services as well. The Telecomm Act of 1996 only requires the CLEC's to offer their services for resell when its operations result in it being the "dominant, incumbent carrier." However, the PSC has ruled that the greatest efficiencies will only be achieved if companies are able to make unbundled purchases from all available sources.

The Telecomm Act requires the incumbent LEC to provide "rates, terms, and conditions that are just, reasonable and non-discriminatory" for collocation of equipment when necessary. The cross-connection rates which decide how much the CLEC's would have to pay BA for the DS0 connection suggested by MFS was $0.21. BA proposed $1.12 and the PSC staff split the difference and suggested $0.66. In an unusual move, the PSC ruled the charge would be $1.12 saying the costs suggested by MFS (based on an Ameritech-Illinois tariff) were not good indicators of BA's cost. They did agree to let CLEC's run their own cabling with BAs supervision.

An interesting side note on collocation issues is the arguments on the type of equipment allowed on BA's property and the legality of making BA provide space for the equipment. This issue shows how cumbersome and mired in details opening up a monopoly can become. In a nutshell, first BA said it would only let a "Voice Grade Private Line" in their space. This would mean the CLEC's would have to do all the switching at remote locations which, as AT&T points out, is inherently inefficient. Then BA says that making them collocate someone else's equipment raises constitutional questions on the taking of private property. Give me a break. The PSC basically told BA they have to provide space as long as it was available and that this requirement "is in the public interest".

How much of a discount should CLEC's get when they purchase services from BA and then resell them to the public? The wholesale rates were guided by directives from the FCC that have since been stayed by the courts. The PSC staff has come up with its own method using an avoided cost model that does not use the guidelines proposed by the FCC that are now in question by the courts. So, the PSC went with the staff's recommendation and set the wholesale rate at 19.87%. As opposed to 26.7% requested by AT&T and 12.03% from BA. Sources:

Maryland Public Service Commission News Release: Arbitration (November 8, 1996) Maryland Public Service Commission Resolves Arbitration Issues Presented By Bell Atlantic - Maryland And New Competitive Local Exchange Carriers

Maryland Public Service Commission News Release: Price Cap Plan (November 8, 1996) Maryland PSC Adopts Price Cap Plan

The Washington Post November 9, 1996 Md. Panel Acts To Resolve Phone Dispute Pg. H2

Telecom Gear Volume 13, Number 10 FCC Proves Commitment to Local Competition Pg. 151

Maryland Public Service Commission Document 85 MD PSC Pg. xxi, xxiii

Maryland Public Service Commission Document 86 MD PSC Pg. xxxi

Maryland Public Service Commission Order No. 73011 Case No. 8715 In The Matter Of Inquiry Into Alternative Forms Of Regulating Telephone Companies

Maryland Public Service Commission Order No. 73010 Case No. 8731 In The Matter Of Petitions For Approval Of Agreements And Arbitration Of Unresolved Issues Arising Under Section 252 Of The Telecommunications Act Of 1996.

Chrys Wilson Maryland Public Service Commission (410) 767- 8047 Miscellaneous Telephone Calls.




                     BASIC RESIDENTIAL SERVICES                      

Residence Service Charges         Long Distance Message Restricition  

Residence Dial Tone               Economy Service                     

Residence Usage                   Denied Service Restoral Charge      

Tel-Life (Link -Up America)       Directory Assistance (Residential)  


BASIC/OTHER SERVICES                                                    

Business Dial Tone          Semi public lines                            

700/900 Audiotex Blocking   PBX Trunks                                   

Business Service Charges    Verification/Interruption Operator Services  

Business Usage              IXC Coinless Telephone Lines                 

Business Repair Service     Directory Assistance (Business)              

Centrex Exchange Access     Non-public, Non-List, Directory Service      
                            (Residential and Business)                   

Coin Call                   Primary White Pages Listing  (Business)      

COCOTS Lines                Shared Tenant Service Lines and trunks       

DID Service                 911 Service                                  

Foreign Exchange Service    Blocks of Numbers for Paging and Mobile      

Home Business Service                                                    


                         ACCESS SERVICES                           

Collocation Services                                               

Switched Access (Other Than High Capacity Service for Direct       


                               DISCRETIONARY SERVICES                                 

Additional alternative number                   Joint User Service                     

Apartment Door Answering Service                List  Service                          

Automatic Customer Trunk Testing                Lo-Cap Private Line                    
                                                (excluding FX)                         

Booths                                          Lo-Cap Special Access                  

Break Rotary Hunt                               Make Busy Arrangements                 

Central Office Data Sets                        Message Toll Services                  

Centrex/DID Intercept                           Messaging Service Interface            

Concentrator-Indentifier Equipment              PBX Night, Sunday and Holiday Service  

Conference Service                              Public Data Network                    

Connect Request Service                         Remote Call Fowarding                  

Construction Charges                            Special Billing Numbers                

Custom Calling Services                         Special Telephone                      
(other than speed dialing and repeat            Numbers                                
call, fixed call forward and services                                                  
for multi-line businesses)                                                             

Foreign Directory (including other              Switched 56 Kilobit                    
Telco)                                          Service                                

Four Wire Service Arrangements                  Switched Redirect Service              

Hot Line                                        Transfer Arrangements                  

Identified Outward Dialing                      Uniform Call Distribution              

ISDN (BRI & PRI)                                Warm Line                              


                              COMPETITIVE SERVICES                               


Audiotex                                      Operator Handling Charges           

Billing and Collection                        Paging Service                      

Centrex Extend Service                        Preferred Telephone Number Service  

Centrex Services                              Repeat Call                         
(Except Exchange Access)                                                          

Custom Call Services                          Speed Dialing                       
 for multi-line businesses                                                        

Distance Learning                             Wats Service                        

Fast Packet Services                                                              
(SMDS, FDDI, Frame Relay)                                                         

High Capacity and DDS Special Access                                              

High Capacity Private Lines and                                                   
DDS Service                                                                       

High capacity for Direct Transport                                                
Switched Access (Includes Entrance                                                
and Direct Trunk Transport                                                        


                                CO-CARRIER SERVICES                                  

Collocated Interconnection to           Co-Carrier Interconnection                    
Unbundled Services                                                                    

Flex-direct Inward Dialing              Landline Co-Carrier Loacal Access             

Number Portability - Interim            Primary Directory Listing for Other           
                                        Telephone Companies                           

Remote Call Forwarding for              Unbundled Services                            

Universal Emergency Number 911                                                        
for Other Telephone Companies                                                         



GDPPI +- three year running average of the CPI +- exogenous changes.