Alternative Forms of Regulation A Rural ILEC’s Views and Experiences

1. Alternative Forms of RegulationA Rural ILEC’s Views and Experiences October 9, 2007 NARUC Staff Subcommittee on Accounting and Finance Conference Timothy W. Ulrich TDS Telecom 608-664-4114 Disclaimer: The viewpoints expressed within this presentation are those solely of the presenter, which may not represent the position and/or viewpoints of TDS Telecom

2. Agenda • Regulation and Competition • Competitive Nature of the Rural Market • Alternative Forms of Regulation • Experiences with Alternative Forms of Regulation

3. Regulation and Competition • Goal of Regulation: Simulate the operations of a competitive market to protect the public interest • Task: Strike a reasonable balance between the extent of regulation and the level of competition in a market, i.e. adapt regulation to market conditions • Rate of Return Regulation—market exhibits monopolistic characteristics • ILECs allowed to recover reasonable expenses and return on investment—links cost and price • Protect consumer and public interest • Limited incentives for innovation and cost reduction • High regulatory costs

4. Regulation and Competition (con’t) • Alternative Forms of Regulation (AFOR) • Appropriate when market exhibits competitive characteristics or to achieve other social goals, e.g. transition to competition, investment commitments • Emphasis on regulating price, not earnings • Competitive pressures will aid in regulating prices • Introduction of innovative and advanced services • Provide pricing flexibility and attractive packages (bundling) for regulatory parity • Alt reg is not dereg; it is just another way to regulate • Again, adapt regulation to market conditions

5. Competitive Nature of the Rural Market • Over the last 5 years, increased competition from wireless, cable, VoIP—i.e., services that provide the same functional capabilities as POTS • Access lines declining • Cutting the cord, dropping second line, and/or not selecting ILEC for new service (only 50% have been selecting) • Switched access MOUs and revenues declining • Barriers to competition—regulatory parity • Pricing flexibility--bundling • Streamlined tariffing • Symmetry • Cross-subsidization allowed for cable—affiliate safeguards • Similar Quality of Service and customer protection standards

6. Measuring Competition • Determining the level of competition—continuum between natural monopoly and effective competition • Telecom market reflects the trend towards full technological and functional convergence, with wireless, cable and Internet service options now being direct substitutes for traditional landline services provided by both ILECs and CLECs • Structural and behavioral measures: Measures to determine a firms ability to raise prices above a competitive level without losing sales for a sustained period of time • Structural: Quantifiable--market shares and concentration factors (e.g., Hirschman-Herfindahl Index, 4-Firm Ratios); elasticity of demand/supply; relationships between price and cost • Behavioral: Dynamics of a competitive market to assess whether there is sufficient pressure on a company to set prices at competitive levels, i.e., determining the actions of the firms within and outside of the market

7. Retail rate regulation of ILECs (December 2006) Qwest AFOR Pending NRRI 07-04, State Retail Rate Regulation of Local Exchange Providers as of December 2006; April 2007

8. Retail rate regulation of CLECs (December 2006) NRRI 07-04, State Retail Rate Regulation of Local Exchange Providers as of December 2006; April 2007

9. TDS Telecom AFOR States For those states still under ROR, options do exist (except for AZ’s constitutional limits) and we have determined to either continue to monitor the regulatory environment and/or pursue an AFOR

10. Types of AFORs • Various Types of Plans—developed over time • Rate Case Moratoria—agree to no earnings review/rate case for a set period • Earnings/Revenue Sharing—earnings above a certain level shared with customers • Incentive Regulation • Price Cap—mainly RBOCs (may include productivity offset) • Pricing flexibility • Full or Partial Deregulation (service-by-service deregulation) • Statutorily Defined vs. Negotiated Plans • Administrative Rules: Help or Hindrance? • Generic (off the shelf) AFOR plans • Ability to pull plan, i.e., if file stipulated plan it cannot be changed without the ability for the company to withdraw it

11. Potential Benefits of AFOR • Benefits to Customers • Limit on rate changes • New services • Increased choices • Benefits to Industry • Regulatory Stability • Pricing Flexibility • Lower regulatory costs • Benefits to Government • Lower regulatory costs • Allow for more focus on consumer protection

12. General Elements of Rural AFORs • Price flexibility for basic services • $X per year—customer petition process • Rate freeze for a period than flexibility • GDP-PI less productivity factor (generally 1-2% offset) • Capped by RBOC rates or state-wide average • Limited price constraints on non-basic • Bundling—discounts allowed (reg and dereg) • Rate rebalancing—lower intrastate access on a revenue neutral basis • Infrastructure and quality of service measures • Streamlined tariff—one day effective subject to suspension • Competitive Commitments—removal exclusive franchise, rural exemption • Suspension of statutes--e.g., depreciation • Exogenous adjustments

13. Experience under AFOR • Success of an AFOR depends on its goals—industry, government and consumer goals • Promote competition • Lowering of access rates • Regulatory parity • Infrastructure investment and modernization • Regulatory stability • Lower regulatory costs • Rate stability for customers • Consumer protection

14. Observed Effects of AFOR • More likely to deploy new services in companies under AFOR • Small companies that have incentives/penalties built into their pricing mechanism for service quality/infrastructure investment appear to maintain better service and invest more, but it is not conclusive • Small companies that offer wholesale tariffs and waive their state franchise protection have seen more entry into their territory by resellers and CLECs • TDS Telecom companies under AFOR have not raised basic rates except for mandated revenue-neutral adjustments • TDS Telecom non-basic (optional services) rates have been raised in several companies under AFOR but the generation of revenue from such increases has been minimal • Stated state commission public policy goals of lowering access rates and lowering the barriers to entry for competitors have been achieved under most AFORs

15. Favorite Components of an AFOR • Favorite Elements of an AFOR (besides dereg) that TDS Telecom has elected/negotiated • No earnings review prior to and during plan • Basic service: $X amount or percentage per year • Non-basic Service: No pricing limitations • Access rates: Ability to rebalance on revenue neutral basis • Tariff: 1-30 day notice for basic; 1 day for non-basic • QoS Standards—parity with competitors • Misc: Ability to opt back into ROR or modify plan

16. Least Favorite Components of an AFOR • Least Favorite Elements of AFORs that TDS Telecom has elected/negotiated • Initial earnings review • GDP-PI minus productivity offset for basic • Limitations on non-basic rates • Incentives/Penalties for achieving set investment amounts per access lines and/or QoS measures tied to pricing mechanism • Waiving of rural exemption

17. Pertinent Resources from NRRI • NRRI 07-06; Assessing Wireless and Broadband Substitution in Local Telephone Markets; (June 2007) • NRRI 07-04; State Retail Rate Regulation of Local exchange Providers as of December 2006; (April 2007) • NRRI 96-19; Determining When Competition is “Workable”: A Handbook for State Commissions Making Assessments Required by the Telecommunications Act of 1996; (July 1996) • NRRI 94-30; Measuring the Impact of Alternative Regulatory Pricing Reforms in Telecommunications; (December 1994) • NRRI 88-1; Evaluating Competitiveness of Telecommunications Markets: A Guide for Regulators; (January 1988)