Incentives in incentive regulation, as in many other types of regulation, depend on operational details. Pacific Bell’s public rate detail filings under its FCC interstate communications services price caps illustrate the importance of obscure details for the operation of price caps.
Among the thousands of Pacific Bell rate elements filed from 2003 to 2009 are some revenue-aggregate rate elements. These elements have notional demand or rates (the notional form has actually changed across years) of 1. For example, from 2003 to 2009 Pacific Bell filings have included “miscellaneous revenue” rate elements. The demand is reported as 1, and the rate as the total revenue, or vice versa. In the 2009 filing, such miscellaneous revenue totaled about $37 million. Revenue for expediting orders has been similarly reported. It totaled about $18 million in the 2009 filing.
Price caps don’t work effectively with such aggregate revenue elements. These elements treat price caps as revenue caps. Revenue caps have much different incentive properties than price caps. A revenue cap constrains a firm’s ability to grow demand for its products. In particular, providing extra services reported as miscellaneous revenue and providing additional expediting services appears like an increase in prices. That’s fundamentally inconsistent with the basic idea of prices caps.
Both BellSouth and Pacific Bell have include aggregate credits (negative revenue) as rate elements in their price caps. Since 1995, BellSouth has included in its price caps negative revenue, without any demand or rates, for Service Assurance Warranty (SAW) credits. In filing year 2000, these credits amounted to about $11 million. These credits are money BellSouth pays its customer for BellSouth service outages.[1] Hence BellSouth service outages penalized through payments to its customers function like price reductions in price caps. Price caps are not meant to encourage service outages.
Pacific Bell has also included aggregate credits (negative revenue) as rate elements in its price caps. In the Pacific Bell filings, these credits are discounts associated with various types of volume and term rate plans. Just as for miscellaneous revenue, the discount credit revenues are reported with demand of 1, and the rate as the total revenue, or vice versa. From 2003 to 2008, the negative discount credit revenue averaged $28 million per year. In Pacific Bell’s 2009 filing, discount credit revenue soared to $120 million. These credits are not easy to associate with any particular prices, but they function like price reductions under price caps. Discount credits reported without any associated demand and rates obscure actual prices under price caps.
The obscurity of discount credits is not merely a theoretical problem. Managed Value Plan (MVP) credits account for all the discount credits in Pacific Bell’s 2009 filing. MVP billing discounts include commitment discounts that grow from 9% in year 1 to 15% in year 5. MVP billing discounts also include service level assurance discounts of up to 2% for Pacific Bell failure to meet agreed service quality standards.[2] To the extent that MVP credit revenue in Pacific Bell’s price cap filing includes such credits, the situation is like that for BellSouth’s Service Assurance Warranty credits.
Even assuming that Pacific Bell’s reported MVP credits in 2009 include service quality failure credits, the MVP credits are large relative to corresponding reported service revenues. For example, Pacific Bell reported about -$37.8 million as “DS3 MVP credit” in its 2009 filing. Pacific Bell also reported a total of $144.8 in price-cap DS3 revenue in its 2009 filing. Assuming the largest (year 5) MVP credit of 14% plus 2% for service quality failure implies DS3 price-cap MVP revenue of $236 million. That’s nearly $50 million greater than the DS3 revenue that Pacific Bell reported under price caps, before subtracting credits (negative revenue). Assuming an average discount of 12% (year 3 discount) plus 1% for service quality failures, and assuming half of reported DS3 revenue is not associated with MVP services, then reported price-cap MVP credits imply price-cap MVP service revenue $180 million greater than what was actually reported under price caps. These discrepancies highlight that Pacific Bell’s total discount credits are difficult to relate to particular price-cap service volumes and prices.
Incentive regulation creates additional incentives for regulatory obscurity. Compared to more directed regulation, incentive regulation tends to be associated with more diffuse policy goals. More diffuse policy goals imply greater difficulties in comparing policy goals to outcomes. Less focus on meaningful, concrete, outcome-oriented policy goals increases incentives for regulatory obscurity.
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Data: Pacific Bell rate detail, 1994-1999; Pacific Bell’s undetailed rate elements; BellSouth’s Service Assurance Warranty credits.
Notes:
[1] BellSouth’s Service Assurance Warranty credits are described in BellSouth’s FCC Tariff No. 1, Section 2.4.4. For details on their application in a contract tariff, see Section 25.29.1.(E)(2)(b) (Contract Tariff – No. 026).
[2] For MVP billing discounts associated with volume and term commitments, see Pacific Bell’s FCC Tariff No. 1, Section 22.3.(E)(3). For MVP service level assurance discounts, see Section 22.3.(E)(4).