the real X-factor in price-cap regulation

Price-cap regulation often involves extensive discussion of price-cap index formulas.  These formulas usually account for economy-wide price inflation, or, in a more complex scheme, price trends for the regulated-company’s inputs.  Price-cap index formulas typically also account for productivity growth.  Technical issues associated with measuring and interpreting input prices and productivity growth provide fertile ground for contentious regulatory proceedings among dueling economic experts.

The FCC’s telephone company price-cap regulation has involved extensive discussion of index formulas, bands, and index adjustments.  Informed by a variety of economic studies of productivity growth, FCC telephone company price caps have included a productivity factor (called the X-factor) that was 6.5% prior to 2004.  While alternative inflation indices have been considered, FCC telephone company price caps include an inflation adjustment based on the GDP deflator (2.1% for the 2009 filing).  In addition, Service Band Indices (SBIs) have formally limited price changes in service categories such as special-access DS1s and DS3s to 5% per year. [1]

But at least under FCC telephone company price-cap regulation, detailed issues of rate element structure have had more actual importance than price index rules and adjustments.   Southwestern Bell Telephone Company’s rate detail, like that for Pacific Bell, has included substantial revenue-aggregate rate elements.   Elements with positive aggregate revenue have been included under descriptions such as miscellaneous revenue, expediting charges, and cancellation charges.   Aggregate revenue elements are not relevant to a meaningful price index.  Across Southwestern Bell’s annual access filings from 2002 to 2009, the weight of revenue aggregate elements (not including discount elements) varied from 1.0% to 8.5%.   Those shares are roughly of the same magnitude as inflation adjustments (1.1% to 3.3%), X-factor productivity adjustments (0 to 6.5%), and SBI band limits (2% to 5%) applied to the constructed price indices.[2]

Credit aggregate-revenue elements (which report negative aggregate revenue) are even larger than the positive aggregate revenue elements.  In its 2009 annual filing, Southwestern Bell included Managed Value Plan (MVP) aggregate credit elements for DS1 and DS3 service that amounted to 18% and 24% of reported DS1 and DS3 revenue before subtracting the credit value.  In the special access basket overall, aggregate credit elements amounted to 22% of total basket revenue before credits.   The relation of these credits to rates for services included in the special access basket isn’t clear.[3]  But clearly these credits have more weight in price caps than typical inflation and productivity adjustment factors.

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Data:  Southwestern Bell Telephone rate detail, 1993-2009;  online spreadsheets detailing Southwestern Bell statistics described above (also available as an Excel workbook)

Notes:

[1] FCC telephone company (interstate access) price cap regulations are set out mainly in 47 CFR 61.41 through 47 CFR 61.49.  Updating of the price cap indices (PCIs) is set out in 47 CFR 61.45.   In 1999, FCC price caps included an Actual Price Index (API) and Price Cap Index (PCI) for five service baskets — common line, traffic sensitive, trunking, inter-exchange, and marketing.  In addition, FCC price caps included 40 Service Band Indices (SBIs).  Prior to 1997, lower bounds as well as upper bounds constrained changes in SBIs.  After 1999, a special access basket was split off from the trunking basket, and the marketing basket was eliminated.  By 2009. the number of SBIs had risen to 104, mainly as the result of the permitted number of zones expanding from three to seven.

[2] SBI increases of up to 15% were permitted for SBIs applied at the level of a specific zone for a particular service, e.g. zone 1 for DS1 service.  See 47 CFR 61.47(f).

[3] Southwestern Bell MVP commitment discounts increase from 9% to 14% over the course of the five-year MVP.  In addition, Southwestern Bell offers up to 2% credit for its failure to meet specified service-level assurance standards.  Even if all DS3 service was bought under a MVP, all plans were in the fifth year of the contract, and Southwestern Bell paid the maximum credit for service shortcomings, MVP credits would amount to only 16% of top-line DS3 revenue.  Why DS3 MVP credits amount to 24% of Southwestern Bell’s total price-cap-reported DS3 revenue (before subtracting credit) isn’t clear.  Southwestern Bell’s MVP tariff is Section 38 in its FCC tariff.

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