Bundling Residential Telephone, Internet, and Video Services: Issues for Congress

CRS Report for Congress
Bundling Residential Telephone,
Internet, and Video Services:
Issues for Congress
February 17, 2004
Charles B. Goldfarb
Specialist in Industrial Organization and Telecommunications
Resources, Science, and Industry Division


Congressional Research Service ˜ The Library of Congress

Bundling Residential Telephone, Internet, and Video
Services: Issues for Congress
Summary
Technological advances and deregulatory actions now allow consumers to
obtain their local and long distance telephone services, their high-speed Internet
services, and their video services from competing technologies. The convergence of
previously distinct markets has required companies to seek strategies for holding on
to their traditional customers while seeking new ones. One of those strategies is for
companies to offer bundles of “traditional” and “new” services at a single price that
often represents a discount off the sum of the prices of the individual services. These
bundled service offerings are favored by many consumers. They provide the
convenience of “one stop shopping” and in some situations, by providing the full
panoply of services at a fixed price, make it easier for consumers to comparison shop.
They also are favored by many providers because they tend to reduce “churn” – the
rate at which customers shift to competitors – and allow providers to exploit
economies of scope in marketing.
But bundling also can create public policy issues for Congress. The bundled
offerings typically provide some combination of interstate telecommunications
services, intrastate telecommunications services, and non-telecommunications
services (information services, video services, and even customer premises
equipment) for a single price. The federal Universal Service Fund – the federal
subsidy program that assures affordable telephone rates for high-cost (rural) and
low-income telephone customers as well as for schools, libraries, and rural health
facilities – is supported by an assessment on interstate telecommunications revenues
only. But it is difficult to identify the portion of revenues generated by a bundled
service offering attributable to the interstate telecommunications portion of that
bundle. There is no unambiguous way for providers to assign a portion of the
bundled price to interstate telecommunications services or for fund administrators to
audit that assignment. In addition, some taxes are assessed upon one or more, but not
all, of the services included in various bundled service offerings. This creates the
same assessment and auditing problem for these taxes as exists for the federal
Universal Service Fund. This has important policy implications at a time when many
Members of Congress seek to shelter Internet services – which often are included in
these bundles – from taxation without placing any group of providers at a competitive
advantage or disadvantage.
Some observers have been concerned that bundled service offerings could have
anticompetitive consequences if they foster industry consolidation or if a provider has
market power for one of the services in its bundled offering and can use that offering
to tie that service to a competitive service in a fashion that reduces competition for
the competitive service.
Leaders in both the House and the Senate Commerce Committees have
announced that in the 109th Congress they plan to review and reform the 1996
Telecommunications Act (P.L. 104-104) in light of the market convergence that
underlies the trend toward bundling.



Contents
The Market Forces Driving Bundling..................................1
Wireline-Only Bundling Strategies....................................6
Wireline, Wireless, Video Bundling Strategies...........................9
The Pricing of Bundled Service Offerings..............................12
Public Policy Issues Created by Bundling..............................14
Bundling and the Federal Universal Service Fund...................15
Bundling and Taxes...........................................19
Bundling and Competition......................................19
Conclusion ......................................................23
List of Tables
Table 1. A Sample of Bundled Service Offerings of Major Providers........11
Table 2. Universal Service Assessment Base: Total Interstate and International
End-User Revenues Less Certain Exempt Revenues..................16
Table 3. “Non-traditional” Customers Captured by Local and Long Distance
C arri ers ....................................................20



Bundling Residential Telephone, Internet,
and Video Services: Issues for Congress
Technological advances and deregulatory actions now allow consumers to
obtain their local and long distance telephone services, their high-speed Internet
services, and their video services from competing technologies. Companies that in
the past sold a narrow suite of services in relative insulation from competition now
are actively entering new service markets and also facing entry by others into their
traditional markets. The convergence of previously distinct markets has required
companies to seek strategies for holding on to their traditional customers while
seeking new ones. One of those strategies is for companies to offer bundles of their
“traditional” services and “new” services – typically at a single price that represents
a discount off the sum of the prices of the individual services.
Today, most incumbent local exchange carriers (“ILECs”),1 competitive local
exchange carriers (“CLECs”),2 wireless carriers, cable companies, and satellite
television companies have bundled service offerings that compete, to varying
degrees, with one another.
Leaders in both the House and the Senate Commerce Committees have
announced that in the 109th Congress they plan to review and reform the 1996
Telecommunications Act (P.L. 104-104) in light of the market convergence that
underlies the trend toward bundling.3
The Market Forces Driving Bundling
The trend toward bundled service offerings is driven by both demand and
supply.
Bundled service offerings are favored by many consumers. They provide the
convenience of “one stop shopping” and, to the extent that competitors’ packages


1 ILECs are the carriers that were the monopoly providers of retail local telephone service
before the 1996 Telecommunications Act opened up local markets to competition.
2 CLECs are the companies – including the traditional long distance carriers – that began
providing local telephone service after the 1996 Act removed statutory prohibitions on
competitive provision of local service.
3 See “Stevens Foresees Telecom Act II in 2005,” Communications Daily, January 27,
2004, at pp. 1-2; “Barton Seeking to Lead House Commerce Committee,” Communications
Daily, February 5, 2004, at pp. 1-2; and “Analysts Tell House to Expect Dynamic VoIP
Growth Soon,” Communications Daily, February 5, 2004, at pp. 5-6.

include the same (or a very similar) bundle of services, can make it easier for
consumers to comparison shop, calculate their total telecommunications and media
expenditures, and switch from one provider to another by switching just a single
account. 4
According to J.D. Power and Associates,5 the share of households that report
bundling at least their local and long distance services with one carrier has increased
from 26% in 2002 to 40% in 2003, an overall increase of more than 10 million
households, and customers who bundle services report higher overall satisfaction
than those who are not bundling services. The Yankee Group made a similar finding
– even though bundles have only been available in many parts of the country within
the past year, a third of Americans already receive long distance and local service
from the same company.6 According to Wayne Huyard, president of MCI’s mass
markets division, half of MCI’s consumer-side revenues comes from the 3.5 million
customers of its bundled service and that proportion is expected to increase to 75%
by 2005.7
But the bundling phenomenon extends far beyond the simple packaging of local
and long distance telephone services, and is driven by providers as much as by
consumers. Although bundled offerings can make comparison shopping easier, they
also tend to foster customer loyalty, thereby reducing “churn” – the rate at which
customers discontinue service (in order to shift to competitors). They also allow
providers to exploit marketing economies of scope. As providers enter new markets,
they can market both their traditional services and their new services with a
consolidated sales and marketing force and campaign.
Until recently, most households had no alternative to their local exchange carrier
for local telephone service and no alternative to their local cable system for
subscription video service. The ILECs and cable systems enjoyed relatively stable
relationships with their customers. Customer churn was extremely low because in
most situations there were government-imposed prohibitions on other providers
offering competitive service, leaving customers with no alternative providers to turn
to. But today, CLECs, wireless carriers, and cable systems offer local telephone
service in competition with the ILECs, and satellite systems offer subscription video
service in competition with cable systems. ILECs and cable systems now face rising


4 See Shawn Young, “Phone-Service Bundles Could Backfire as Customers Switch,” Wall
Street Journal, November 7, 2003, at p. B-1.
5 J.D. Power and Associates 2003 Residential Long Distance Service Study press release,
“Customer Satisfaction Increases as Stiff Rate Competition and Bundling Cause Steep Drop
in Long Distance Spending,” July 1, 2003, at p. 1, posted on [http://www.jdpower.com
/news/releases/index.asp].
6 Griff Witte, “An Evolutionary Edge: Local Phone Firms Pass Long-Distance Companies,”
Washington Post, December 3, 2003, at p. E1, citing Yankee Group senior analyst Kate
Griffin.
7 Ibid at p. E1.

levels of customer churn,8 analogous to what AT&T and its long distance competitors
have experienced with their customers since MCI, Sprint, and a host of smaller
facilities-based carriers and resellers entered the long distance market in the 1980s,
and what the wireless carriers have begun to experience as well.9 Competitive entry
and market convergence have increased the churn rate for all providers.
The costs associated with customer churn are substantial. Providers face up-
front costs to capture and serve a customer. To serve that customer profitably, the
provider must recover these costs before the customer changes provider. These costs
include the acquisition (marketing and sales) costs associated with gaining new
customers, retaining existing customers, and winning back customers who leave for
another provider. They also include costs associated with connecting the customer
to the provider’s network and activating service – providing the wireline or wireless
connection, incorporating customer data in the provider’s operating support systems,
sometimes placing equipment on customer premises, etc. If the provider faces high
churn rates, absent a substantial initial customer charge (such as a connection
charge), it may fail to fully recover these up-front costs. One industry analyst has
estimated that wireless providers have per customer acquisition costs of $150 to $300
and payback cycles as long as 14 months.10 Another industry analyst estimates
residential wireless per customer acquisition costs of $300 to $425.11 But the
wireless industry has annual customer churn rates in the vicinity of 30%, which are
expected to grow with the recent implementation of local number portability.12 Thus,


8 According to the J.D. Power and Associates 2003 Residential Local Telephone Customer
Satisfaction Study press release, “Household Switching of Local Service Carriers Increases
as New Players Enter the Local Telephone Service Market,” July 15, 2003, at p. 1, posted
on [http://www.jdpower.com/news/releases/index.asp], “The number of households
reporting they have switched local telephone service carriers in the last year has increased
more than 60 percent in 2003, rising to 10 percent from 7 percent in 2002.” Similarly,
according to the J.D. Power and Associates 2003 Residential Cable/Satellite TV Customer
Satisfaction Study press release, “Average Monthly Spending for Satellite Service Drops
Below Cable Service for the First Time as Cable Market Share Continues to Decline,”
August 19, 2003, at p. 1, posted on [http://www.jdpower.com/news/releases/index.asp],
“Currently, 60 percent of households surveyed subscribe to cable service, down from 68
percent five years ago, while satellite subscriptions have increased from 7 percent of
households in 1998 to 17 percent in 2003.”
9 See footnote 12 below.
10 Glenn Bischoff, “The Principal of Portability,” Wireless Review, November 1, 2003, at
p. 11.
11 J.D. Power and Associates 2003 U.S. Wireless Regional CSI Study press release,
“Customer Loyalty Becoming a More Critical Issue in the Wireless Industry as Phone
Number Portability is Poised to Become a Reality in November,” September 30, 2003, at
p. 1, posted on [http://www.jdpower.com/news/releases/index.asp].
12 See, for example, Glenn Bischoff, “The Principal of Portability,” Wireless Review,
November 1, 2003, at p. 11, Tim McElligott, “Churn plus portability equals Y2K-03,”
Wireless Review, September 1, 2003, at p. 35, and Aude Lagorce, “The Battle Over Cell
Phone Business Accounts,” Forbes.com, [http://www.forbes.com/2003/11/13
/cx_al_1113phones.html], viewed on January 6, 2004. The J.D. Power and Associates 2003
(continued...)

analysts say wireless carriers currently are not able to fully recover their acquisition
costs for a substantial portion of customers. The same is true for other telecom,
Internet, and video service providers.13 The higher the churn rate, the less likely
providers will be able to fully recover their up-front costs from each customer – at
the same time that pressure is placed on providers to increase their efforts (and costs)
for acquiring and retaining customers.14
The high costs associated with churn have spawned an industry of market
researchers to help firms identify customer purchasing patterns and construct
strategies for minimizing churn.15 According to these market researchers, increasing


12 (...continued)
U.S. Wireless Regional CSI Study press release, “Customer Loyalty Becoming a More
Critical Issue in the Wireless Industry as Phone Number Portability is Poised to Become a
Reality in November,” September 30, 2003, at p. 1, posted on
[http://www.jdpower.com/news/releases/index.asp], states that 26% of the subscribers in
its survey stated they had switched wireless carriers at least once in the past 12 months.
Since some of those subscribers may have switched carriers more than once, this suggests
a churn rate in excess of 26%.
13 According to Richard Wolniewicz, “Building a better business one customer at a time,”
[http://telephonyonline.com/ar/telecom_building_better_business/], November 12, 2003,
(viewed 1/12/04), “Customer churn is one of the most pressing issues the
telecommunications industry faces and it affects all types of carriers from cable operators
to mobile service providers. According to a study by Bain & Co., companies can boost
revenues by as much as 85% if they can retain only 5% more of their best customers.”
14 High churn-related costs may have been responsible for the ineffectiveness of one of the
provisions in the 1996 Telecommunications Act intended to foster competitive entry.
Section 252(d)(3) requires the ILECs to make their retail services available to new entrants
at wholesale rates determined “on the basis of retail rates charged to subscribers for the
telecommunications service requested, excluding the portion thereof attributable to any
marketing, billing, collection, and other costs that will be avoided by the local exchange
carrier.” In implementing this requirement, the FCC adopted a rule instructing states to set
wholesale rates by using a methodology that subtracted from retail rates the ILECs’
embedded retail-related costs, which were in the range of 15%-20% of retail rates. This is
sometimes called the wholesale “discount” off retail rates. With competitive entry, and the
resultant customer churn, however, marketing and sales costs for both entrants and
incumbents have risen significantly, and far exceed the 15%-20% discount off retail rates.
New entrants therefore have not found it viable to enter the market by reselling retail ILEC
services at the discounted wholesale rates. The ILECs, on the other hand, have argued
successfully in court that the “discount” off the retail price should be reduced, not increased,
because some retail costs are fixed, will not decline in proportion to the number ofth
customers lost to the resellers, and therefore “will not be avoided.” (Iowa Utilities II, 8th
Federal Circuit Court of Appeals, 219 F3.d at 754). The 8 Circuit has remanded the FCC’s
wholesale pricing rule back to the Commission, which has opened up a proceeding to
address that and other cost rules.
15 Among the many firms that collect data and/or perform churn analysis for providers are
Convergys’ Knowledge Management Services, Yankee Group, In-Stat/MDR, Zelos Group,
iGillottResearch Inc., Gartner Group, Solomon Wolff Associates, Athene Software,
Convergence Consulting Group, Compete Inc., and Dietrich Lockhard Group.

the number of services included in the bundle tends to reduce churn.16 Bundled
service offerings therefore tend to provide an advantageous strategy for large
companies that are able to offer a broad array of services.
Verizon has announced that the company plans to offer consumers as many
services as possible in its bundled offerings, with traditional voice options
supplemented by wireless, video services, and high-speed Internet; according to Jill
Wagner, Verizon vice president of consumer marketing, “It’s not just the [local
companies] and the long distance providers. You have to throw in the six wireless
providers, and you have to throw in the cable companies. That’s the market.”17
BellSouth has the same perspective. Lisa Fox, BellSouth’s director of consumer
marketing, has stated: “Because we can sell them local, long distance, data, wireless
and – soon – video all on one bill, that’s really proved to be a good retention tool for
us. Customers can’t find that in our region with anyone else today.”18
As these large bundled service offerings have grown in popularity, companies
with narrower capabilities that have traditionally offered stand-alone services have
had to partner with larger companies in order to participate in a market environment
that favors bundling.19


16 See, for example, Keith Damsell, “Telecom bundling seen luring customers; Grouping
services together for lower price builds loyalty, trims ‘churn,’ study says,” The Globe and
Mail, 29 September 2003, at p. B8, citing Convergence Consulting Group Ltd. study, The
Battle for the North American Couch Potato, and referring to Cox Communications’
extremely low churn rate with the “triple play” of digital television, high-speed Internet
access, and local telephone service.
17 See Griff Witte, “An Evolutionary Edge: Local Phone Firms Pass Long-Distance
Companies,” Washington Post, December 3, 2003, at p. E1.
18 Vince Vittore and Glenn Bischoff, “Bundling Strategy Provides Soft Landing,”
Telephony, October 7, 2003, at pp. 6-9.
19 For example, Covad Communications, which offers high-speed Internet access service
using DSL technology, increasingly markets its services through the bundled service
offerings of CLECs. See, for example, “AT&T, Covad Extend Consumer Bundle in
Midwest States,” at [http://www.phoneplusmag.com/hotnews/3ch11123256.html], viewed
on 1/7/2004. Covad’s marketing partnerships with many CLECs also have been motivated
in part by the FCC’s Triennial Review Order, 47 CFR Part 51, “Review of the Section 251
Unbundling Obligations of Incumbent Local Exchange Carriers; Implementation of the
Local Competition Provisions of the Telecommunications Act of 1996; Deployment of
Wireline Services Offering Advanced Telecommunications Capability; Final Rule and
Proposed Rule,” Federal Register, Vol. 68, No. 169, September 2, 2003, at pp. 52276ff.
That Order phases out the “line sharing” requirement, under which companies such as
Covad could lease from the ILEC, at cost-based rates, the “data” portion of the local loop
to a customer’s premises to offer that customer high-speed Internet access service while that
customer continued to receive voice service from the ILEC. At the same time, the Order
imposed a “line splitting” requirement, under which an ILEC must make the local loop
available in such a fashion that a CLEC, such as Covad, that specializes in offering high-
speed Internet access (data) service, and another CLEC, such as AT&T or MCI, that
specializes in offering voice services, could jointly use the loop to provide the customer both
voice and Internet access services. Under line splitting, one of the CLECs leases the entire
(continued...)

Since identical bundled offerings facilitate comparison shopping, providers have
a strong incentive to differentiate or distinguish their bundled service offerings from
their competitors’ offerings. Otherwise, their primary way to hold on to customers
is to keep cutting prices. The best way to differentiate a bundle is to include a service
that competitors either cannot offer at all or cannot offer at the same quality, cost, or
convenience.
Wireline-Only Bundling Strategies
Most wireline providers – ILECs and CLECs – offer bundled local and long
distance telephone services. Unadorned by special features, long distance service and
(increasingly now) local service have become commodities, subject to fierce price20
competition and high churn levels. Although many CLECs initially attempted to
enter the residential market by using their own network facilities or by reselling the
ILECs’ retail products, in almost all cases CLECs have abandoned those approaches
as not competitively viable. Instead, most CLECs provide residential local service
by leasing network facilities from the ILECs, in particular by leasing the unbundled
network element (“UNE”) known as UNE-platform or UNE-P,21 under terms set out
in the 1996 Telecommunications Act, as implemented by the FCC and state public
service commissions.22 One group of CLECs has estimated that in the second quarter
of 2003 80% of all residential local service offered by CLECs as part of bundled
service offerings was provided using UNE-P leased from the Regional Bell Operating23
Companies (“RBOCs”). Some ILECs have attempted to differentiate their bundled


19 (...continued)
loop from the ILEC at cost-based rates. The two CLECs then work out between themselves
the charges for use of the two (voice and data) portions. The ILEC is merely obligated to
make it physically possible for the two CLECs to split the loop, for example, by allowing
the CLECs to collocate their equipment with one another within the ILEC’s central office.
20 See, for example, Shawn Young, “Phone-Service Bundles Could Backfire as Customers
Switch,” Wall Street Journal, November 7, 2003, at p. B1, quoting Wayne Huyard, president
of mass markets for MCI: “Churn has increased. We are entering an era of commoditization
for local and long distance.”
21 UNE-platform consists of the combination of the local loop from the customer premise
to the ILEC’s central office and the switch port at the central office.
22 The 1996 Telecommunications Act attempted to foster competitive provision of local
telephone service by requiring the ILECs to make available to new entrants those elements
of the ILEC networks to which the new entrants needed access in order not to be “impaired”
in their ability to offer local service. This requirement that the ILECs unbundle the elements
of their networks and make them available to CLECs should not be confused with the
current strategy of many providers to bundle retail services into offerings intended to reduce
customer churn.
23 See “Measuring RBOC Dominance of Bundled-Services: The Progress of Competition
Under the New Social Contract,” an undated report of the PACE Coalition (a coalition of
small CLECs) prepared in late 2003, at p. 3, posted on [http://www.pacecoalition.com],
viewed on 2/10/2004. The FCC’s semi-annual report, Local Telephone Competition: Status
as of June 30, 2003, which was released in December 2003 and is available at
(continued...)

offerings from CLECs by including vertical features such as voice mail and privacy
management (to block telemarketers) that are not part of the UNE-P they are required
to provide to CLECs but that CLECs are unlikely to be able to offer at equal quality
or cost on their own.24
Another way that ILECs attempt to differentiate their bundled service offerings
from CLEC offerings is to offer high-speed Internet access service by using DSL
technology to provide both voice and data services over the existing copper telephone


23 (...continued)
[http://www.fcc.gov/wcb/stats], presents data collected from both ILECs and CLECs for the
same period of time. Although it is not possible to directly compare the PACE and FCC
data, they appear to describe a consistent scenario. According to the CLEC-provided data
presented in Table 3 of the FCC report, in June 2003 58.5% of all CLEC end-user switched
access lines were provided using UNEs, 18.2% were provided by reselling ILEC retail
services, and 23.3% were CLEC-owned (i.e., self-provisioned). According to the CLEC-
provided data presented in Table 2 of the report, 62% of CLEC end-user switched access
lines served residential and small business customers and 38% served large business
customers. According to the ILEC-provided data presented in Table 4 of the report,
13,026,000 of the 17,231,000 (75.6%) end-user switched access lines that ILECs have
provided to CLECs as UNEs were provided as part of UNE-P (as UNEs with switching).
Virtually none of the access lines self-provisioned by CLECs serve residential or small
business customers (the exception being the unusual case of a residential or small business
customer being located on the same site as a large business customer) and virtually none of
the CLECs’ large business customers are served by resold ILEC retail service (ILEC retail
service would rarely meet the needs of a large business customer). Also, those CLEC large
business customers not served by CLEC-provisioned loops are far more likely than
residential and small business customers to have been served by unbundled loops rather than
UNE-P, since it is these large business customers that CLECs can serve most efficiently
with their own switching. The FCC data suggest that approximately 14.7% of CLEC
switched access lines used UNEs and served large business customers [38% minus 23.3%].
44.2% of CLEC switched lines were served by UNE-P [(58.5%)(75.6%)] and 14.3% by
UNE-loop [58.5 minus 44.2]. It is likely that virtually all of the 14.3% of CLEC UNE-loop
switched access lines served large business customers, since it is far more efficient to serve
these customers than residential and small business customers with UNE-loop. Thus, only
about 0.4% of CLEC switched access lines used UNE-platform and served large business
customers [14.7% minus 14.3%]. This suggests that 43.8% of CLEC switched access lines
served residential and small business customers using UNE-P, which would be 70% of the

62% of CLEC switched access lines serving residential and small business customers.


While this number may be slightly overstated because it implicitly assumes no residential
and small business customers are served by UNE-loops, it is not out of line with the 80%
PACE findings. The FCC data cover all CLEC lines; the PACE data cover only those lines
sold as part of a bundled local-long distance service offering. While virtually all CLECs
that use UNEs are offering such bundles, some of the cable companies, which do not use
UNEs, offer local telephone service but not bundled with long distance service. Thus one
would expect the figure constructed from the various FCC tables (70%) to be lower than the
PACE figure (80%).
24 ILECs are not required to offer voice mail because it is an information service, not a
telecommunications service, and thus not subject to the 1996 Act’s unbundling
requirements. Similarly, privacy management services are provided through the ILECs’
Advanced Intelligent Networks (AIN), which are proprietary and which the ILECs are not
required to make available to CLECs.

lines. Although in many geographic locations it is not feasible for CLECs to deploy
their own DSL equipment to serve residential customers,25 the DSL equipment is not
available as a UNE, nor as part of the UNE-P. As a result, in many geographic areas,
CLECs do not, themselves, offer bundled voice and DSL service. Even Covad,
which specializes as a provider of high-speed Internet access and continues to expand
its footprint, will have collocated DSL equipment in only 2,000 (out of more than
10,000) ILEC central offices by mid-2004, and will be able to reach somewhat less
than half (under 50 million) of U.S. households.26 Most residential customers
seeking to receive both voice service and high-speed Internet access service over
their telephone lines have the following choices: to receive both voice and Internet
access service from their ILEC; to receive voice service from their ILEC and high-
speed Internet service from a provider such as Covad, with that Internet service
provider collocating its own DSL equipment in the ILEC’s network and leasing the
data portion of the ILEC line serving that customer at negotiated prices that need not
reflect costs;27 or to receive the two services through a “line splitting” arrangement28
under which a CLEC that specializes in offering high-speed Internet access (data)
service, and another CLEC that specializes in offering voice services, could jointly
use the unbundled loop to provide the customer both voice and Internet access
services. This last option has allowed some CLECs, including AT&T and MCI, to
respond to the ILECs’ bundled local/long distance/high-speed Internet access
offerings by entering into contractual marketing relationships with Covad, to offer
a similar bundled service. But it is more complex – and more expensive – to
coordinate line splitting than for an ILEC to offer the two services using its own
facilities.
According to a December 5, 2003 SBC press release,29
Long distance and DSL help [SBC] reduce [its] churn:
!Adding long distance to an access line reduces the company’s churn
rate by 9 percent.


25 To offer its own high-speed Internet service to a customer over ILEC lines, a CLEC must
collocate its own DSL equipment (DSLAMs) at a particular point in the ILEC’s network.
It is only viable to deploy such equipment in places where the CLEC can expect to capture
enough customers for the DSL service to justify the investment and where there is space at
the ILEC location to place that equipment.
26 Communications Daily, January 8, 2004, at p. 6.
27 In its September 2003 Triennial Review Order, the FCC ended the “line sharing”
requirement that ILECs make the data portion of their local loops available to data CLECs
at cost-based rates. However, the FCC has grandfathered cost-based prices for the data
portion of the customer line for those customers who were served by the high-speed Internet
access service provider prior to that Order.
28 See footnote 19 above.
29 “SBC Communications Provides Progress Report on Major Growth Strategies, Outlines
Broad Service and Cost Initiatives,” SBC-Press Room, November 13, 2003,
[ h t t p : / / www.sbc.com/ ge n/ pr ess-r oom?pi d =4800&cdvn =news&newsar t i c l e i d =20721],
viewed on 12/05/2003. This statement also appears at “SBC Provides 2004 Outlook,
Updates Major Trends,” [http://convergedigest.com/Bandwidth
/sample_category_article.asp?ID=9406], viewed on 1/9/2004.

!Churn drops by 61 percent when a DSL line is added to an SBC
bundle.
!Together, long distance and DSL reduce churn by 73 percent.
Wireline, Wireless, Video Bundling Strategies
Today, bundled offerings have expanded far beyond the telephone and high-
speed Internet access services traditionally offered by ILECs and CLECs, to include
video and wireless services as well. Initially, each provider’s bundles tended to be
limited to the combination of services that could readily be provided by the firm’s
underlying network technology, and thus each provider tended to offer different
combinations of services. Traditional circuit-switched public telephone networks,
coaxial cable television networks, wireless networks, Internet protocol networks, and
satellite systems each have their advantages and limitations with respect to services
offered. To minimize market fallout from the limitations of their chosen
technologies, however, providers increasingly are teaming with companies that have
different underlying network technologies in order to provide complete bundled
offerings.
For example, the incumbent local telephone companies have been able to
quickly enter the long distance market as soon as they received government approval
to do so.30 Verizon already serves 15.9 million long distance customers, SBC 11.5
million, and BellSouth 3.4 million.31 But to date it has not proved viable for local
telephone companies to use their circuit-switched telephone networks to offer video
services. Instead, in order to compete with the bundled offerings of cable operators,
many ILECs are entering into partnership arrangements with satellite companies to
market satellite television services as part of a telephone company bundled offering.
Both Verizon and BellSouth have entered into marketing agreements with DirecTV
to begin offering subscription video services as part of their bundled service offerings
in 2004.32 Similarly, SBC has entered into a co-branding deal with Echostar, also
beginning in 2004, to offer “SBC Dish Network.”33
Similarly, local cable television systems’ fiber optic platforms have helped cable
companies become the largest providers of high-speed Internet access (through the


30 Under the terms of the 1996 Telecommunications Act, the Regional Bell Operating
Companies (the old Bell System portions of Verizon, SBC, BellSouth, and Qwest) were
required to pass a 14 point checklist demonstrating that their markets have been opened to
competitive provision of local telephone service before they were allowed to enter the long
haul long distance market in their respective service areas. They have now been approved
to offer long distance service in all states.
31 Griff Witte, “An Evolutionary Edge: Local Phone Firms Pass Long-Distance
Companies,” Washington Post, December 3, 2003, at p. E1.
32 Mike Farrell, “DBS Pitches: MSOs Swine, Telcos Divine,” Multichannel News,
November 24, 2003, at p. 1, and “BellSouth announces new options,” Alexandria Daily
Town Talk, December 15, 2003, at p. 8B.
33 Mike Farrell, “DBS Pitches: MSOs Swine, Telcos Divine,” Multichannel News,
November 24, 2003, at p. 1.

use of cable modems). As of September 30, 2003, 15 million cable customers
received cable modem service.34 But many cable systems have not yet made the
network upgrades needed to offer telephone services; as of September 30, 2003, there
were 2.5 million residential cable telephony customers in the United States.35
Recently, however, a number of cable systems have announced that rather than
undertake the expensive investment needed to upgrade their coaxial cable networks
to provide telephone service – and have to continue to pay high access charges to the
ILECs to terminate calls – they plan to use Internet Protocol technology to offer voice
services, in some cases jointly with long distance carriers.36 Cable companies have
undertaken this bundling strategy at least in part as a customer retention strategy
against the satellite companies.37 Similarly, some cable companies are deploying
video-on-demand service to capture and maintain customers.38
According to Jeffrey Halpern, an analyst at Sanford C. Bernstein & Co.,39
wireless is the key to distinguishing phone companies from their cable television
rivals, many of which have phone and Internet access packages but don’t have
wireless offerings. The ILECs that have wireless joint ventures (SBC and BellSouth
jointly own Cingular Wireless; Verizon has a joint venture with Vodafone Group that
offers Verizon wireless service in the U.S.) have expanded their bundled service
offerings to include wireless options that neither the cable companies nor the CLECs
can so readily offer. There appears to be strong market pressure on these cable
companies and CLECs to establish relationships with wireless carriers not affiliated
with the ILECs to offer a bundled service that includes wireless service. AT&T is
testing a bundled package that includes wireless service from its former wireless unit,
AT&T Wireless Services.40 But there are a limited – and apparently shrinking –
number of unaffiliated wireless carriers. Indeed, the announcement on February 17,


34 National Cable and Telecommunications Association,
[http://www.ncta.com/Docs/PageContent.cfm?pageID=93], viewed on 1/12/04.
35 National Cable and Telecommunications Association,
[http://www.ncta.com/Docs/PageContent.cfm?pageID=32], viewed on 1/12/04.
36 See Matt Richtel, “Time Warner Deal Raises Ante in Cable’s Bid for Phone Market,”
New York Times, December 9, 2003.
37 According to the J.D. Power and Associates 2003 Residential Cable/Satellite TV
Customer Satisfaction Study press release, “Average Monthly Spending for Satellite TV
Service Drops Below Cable Service for the First Time as Cable Market Share Continues to
Decline,” August 19, 2003, at p. 2, posted on [http://www.jdpower.com
/news/releases/index.asp], “One area where cable providers may have an opportunity to stem
this migration to satellite is in bundling telephony and Internet access with cable TV service.
With growing consumer desire to combine multiple services in a single bill for convenience
and simplicity, the study finds that 34 percent of cable subscribers want to combine their
cable service with some other telecommunications product or service.”
38 See Matt Stump, “Cable Ops Touting VOD As Anti-Churn Weapon,” Broadband Week,
March 4, 2003, viewed on [http://www.broadbandweek.com
/news/020304/020304_cable_cableops.htm] on 1/12/04.
39 See Shawn Young, “Phone-Service Bundles Could Backfire as Customers Switch,” Wall
Street Journal, November 7, 2003, at p. B1.
40 Ibid at p. B1.

2004 that AT&T Wireless has accepted an acquisition bid made by Cingular41 could
remove AT&T Wireless as an independent source of wireless service for AT&T if
the acquisition is completed.42
Similarly, wireless carriers now are offering bundled packages that include
local, long distance, and Internet access services, and satellite providers are offering
various video packages and experimenting with non-video services. These
companies seek bundle components that will reduce churn.
Table 1 presents a sample of bundled service offerings of major providers
prepared by one industry observer. It is presented with the caveat that some of the
specific bundles, prices, and geographic reaches listed are already out of date because
virtually every week some provider is either expanding its bundle, extending the
geographic area in which it is offering its bundle, or changing its prices.
Table 1. A Sample of Bundled Service Offerings of
Major Providers
Package Components Price Availability
AT&T DSLUnlimited local, local toll, and$89.90 toNJ, NY, MD,
Service with Onelong distance phone service, and$94.90* MA, VA
Rate USADSL
BellSouthUnlimited local, local toll, and$124.98 in GANine states in
Ultimate Answerslong distance phone service,(prices vary inBellSouth
DSL, and 500 Cingular wirelessother states)territory
minutes and 5,000 minutes nights
and weekends
Comcast Corp.sHigh-speed Internet, cable TV$15 discount on35 states plus DC
bundleInternet: $42.95
down from
$57.95**
The Cox ValueCable TV, unlimited local and$120.89New England


Bundlelong distance phone service with
feature package and high-speed
Internet
41 “Cingular to Acquire AT&T Wireless, Create Nation’s Premier Carrier,” February 17,
2004, at [http://www.attwireless.com/press/releases/2004_releases/021704.jhtml], viewed
on 2/17/04.
42 Cingular succeeded in an informal auction process created when AT&T Wireless
announced in January 2004 that its board of directors had authorized the company to
entertain acquisition offers after receiving overtures from nearly half a dozen suitors,
including Cingular, Nextel Communications, Vodafone, NIT DoCoMo, and AT&T. See
Matt Richtel and Andrew Ross Sorkin, “AT&T Wireless for Sale as a Shakeout Starts,” New
York Times, January 21, 2004, at p. C1. According to the article, the “move by AT&T
Wireless and its potential buyers indicates that one of the nation’s most fiercely competitive
industries is heading toward a long-awaited consolidation that may be the tip of a
multilayered and complex merger process around the world.”

Package Components Price Availability
MCI’sUnlimited local, local toll, and$84.99 to29 states plus DC
Neighborhoodlong distance phone service, and$109.99
HiSpeed DSL
Qwest’s SimplyUnlimited local and domestic$49.99 [addMost areas of CO,
Phone Servicelong distance and variousunlimited localID, IA, MN, NE,
premium calling featureswireless forND, NM, OR,
$49.99 or addSD, UT, WA, and
DSL forWY
$29.99]
SBC TotalUnlimited local, local toll, and$90 to $95AK, CA, CT, IL,
Connectionslong distance phone service,KS, MI, MO, NV,
DSL, and 300 anytime wirelessOH, OK, TX, WI
minutes [Cingular Wireless] and
5,000 minutes nights and
weekends
Sprint CompleteUnlimited local, local toll, and$179.99 to36 states plus DC
Sense Unlimitedlong distance phone service and$189.99
with PCSunlimited wireless
Verizon FreedomUnlimited local, local toll, and$114.89 toMA, NJ, NY, PA,
Alllong distance phone service,$124.89VA
DSL, and 400 anytime wireless
minutes, unlimited nights and
weekends and 1,000 mobile-to-
mobile minutes
Vonage PremiumUnlimited local, local toll, and$34.99***50 states
Unlimited Planlong distance phone service
Source: Josh Long, “Unwrapping the Bundle: Telcos Tout Retention Factor, But Packages Reduce
Profit Margins, [http://www.xchangemag.com/articles/3c1coverstory1.html], viewed on 1/6/2004.
* excludes $20 discount first three months on DSL; ** excludes the charge for cable television service
available at various levels depending on the specific service chosen; *** excludes charges for a
telephone line and DSL service or for cable modem service that are needed in order to use Vonages
service.
The Pricing of Bundled Service Offerings
The pricing structure of bundled offerings tends to follow a few patterns.
Bundled telephone service typically includes unlimited local, local toll, and long
distance services at a single flat rate. It sometimes is difficult for consumers to
compare that single rate to the sum of the rates of the components because the
components (especially long distance and local toll service), when sold as stand-
alone services, usually are sold on a usage (rather than flat rate) basis. Typically, the
flat rate bundle is the cheaper option for consumers who are heavy telephone users,
but the more expensive choice for consumers who are light users. According to a



Wall Street Journal article,43 “Some people who don’t make a lot of calls and don’t
want services like call waiting soon discover that most unlimited packages, which are
geared to high-end customers, aren’t economical for them.” This partially explains
why MCI’s Neighborhood product, “which costs $50 to $60 a month in most areas,
loses about half its new customers within the first six months, though turnover drops
after that.”44
ILECs and CLECs that supplement their wireline telephone bundles with non-
wireline telephone services, such as high-speed Internet access or wireless service or
even video service, typically offer a bundle of their “traditional” services at a fixed
price and then allow customers to add to that bundle by paying flat prices for
additional services, with the prices for those additional services typically being lower
when purchased as part of the bundle than the stand-alone prices for those additional
services. Similarly, cable companies typically will supplement their subscription
television offerings with high-speed Internet access and telephone services that have
a separate add-on price that is lower than the stand-alone price for those services.
According to a New York Times article,45 “Cable companies, which face little
competition from rival cable companies in many markets, have a great deal of
leverage in pricing and are eager to expand their universe of high-speed Internet
customers because the business has a higher margin than the video business. Cable
customers who buy both the video package and high-speed Internet access pay
somewhat less than customers who buy only Internet service.” A perhaps more
nuanced explanation for this pricing behavior is that cable companies’ only
competitors for subscription television are the satellite companies, which in most
circumstances cannot offer their customers competitive high-speed Internet access
service. Cable companies thus can reduce competitive churn by offering high-speed
Internet service at a discount that is available only when the customer also takes cable
service. For example, cable customers who switch to DirecTV to get their sports
package likely will pay $49 for high-speed Internet access from their cable company,
but would only have to pay $39 for that service if they bought it along with cable
servi ce. 46
The price for the bundle, or for add-ons to the bundle, sometimes will vary by
customer class, with discounts offered only to new customers or only to customers
that the provider is trying to “win back” from another provider or only to some other


43 Shawn Young, “Phone-Service Bundles Could Backfire as Customers Switch,” Wall
Street Journal, November 7, 2003, at p. B1.
44 Ibid at p. B1. The high churn rates that MCI and other CLECs are experiencing with
their bundled services (Adam Quinton, a telecommunications analyst at Merrill Lynch,
estimates that turnover in bundled plans offered by rivals to the Bell Operating Companies
is as high as 8% a month – or nearly 100% in a year – in some highly competitive areas) also
is the result of aggressive ILEC campaigns to “win-back” customers lost to the CLECs and
to the “sticker shock” customers experience because advertised rates typically exclude fees
and taxes that can add as much as 15% to the customer bill.
45 Geraldine Fabrikant, “In Fight Between Cable and Satellite, Customers Gain an Edge,”
New York Times, December 1, 2003, at p. C22.
46 Ibid at p. C22.

targeted group of customers. For example, the ILECs are making aggressive efforts
to woo back customers with extra incentives, including Visa gift cards and special
discounts or credits available only to returning customers.47 Similarly, cable
companies are making aggressive efforts to win back subscription video customers
from satellite video providers and high-speed Internet access customers from ILECs.
As discussed below in the section on Bundling and Competition, sometimes these
efforts can lead to claims that the incumbent is engaging in a price war or even
predatory or other anticompetitive pricing behavior.
Bundling, while an effective strategy for reducing churn among high-end
customers, also will result in previously full-price customers switching to discount
plans, according to Jeffrey Halpern of Sanford C. Bernstein & Co.48 According to
a research report prepared by Roger Sachs, of Cathay Financial, sales of bundled
packages have had a mixed impact on the balance sheet: “While churn rates have
been reduced, [Bell] profit margins are falling under pressure. In an effort to reduce
local churn, SBC has aggressively provided high-speed data and long-distance
service at the expense of profitability.”49
Bundling appears to be primarily a strategy for deterring churn among high-
usage customers, at the expense of profit margins. One possible consequence of
bundling is that providers will feel the need to buttress their overall profit margins
by raising the rates for their stand-alone services, which are the services most
frequently purchased by low-usage customers. These customers tend to be less price
sensitive than larger users and thus tend to be loyal to their traditional providers.
Similarly, low-income and elderly customers are less likely than more affluent and
younger customers to seek high-speed Internet access and wireless services, and thus
more likely to purchase stand-alone telephone services rather than bundled service
offerings.
Public Policy Issues Created by Bundling
Bundling potentially creates several public policy issues for Congress, including
the on-going viability of the current funding mechanism for the federal Universal
Service Fund, proper treatment of taxes that are assessed on only a subset of services
included in a bundled offering, and maintaining competitive markets.


47 Shawn Young, “Phone-Service Bundles Could Backfire as Customers Switch,” “Wall
Street Journal, November 7, 2003, at p. B1.
48 Ibid at p. B1.
49 See Josh Long, “Unwrapping the Bundle: Telcos Tout Retention Factor, But Packages
Reduce Profit Margins,” [http://www.xchangemag.com/articles/3c1coverstory1.html],
viewed on 1/6/2004.

Bundling and the Federal Universal Service Fund
Bundled offerings typically include some combination of interstate
telecommunications services, international telecommunications services, intrastate
telecommunications services, and non-telecommunications services (information
services, such as Internet access, video services, and even customer premises
equipment) for a single price. The federal Universal Service Fund – the federal
subsidy program that assures affordable telephone rates for high-cost (rural) and low-
income telephone customers as well as for schools, libraries, and rural health
facilities – is supported by an assessment on interstate and international
telecommunications revenues only.50 But it is difficult to identify the portion of
revenues generated by a bundled service offering attributable to the interstate and
international telecommunications portion of that bundle. Providers must assign a
portion of the bundled price to interstate and international telecommunications
services and the fund administrators must be able to audit the attribution to protect
against companies gaming the system by understating the interstate and international
telecommunications portion. There often is no way, however, to unambiguously
assign a portion of the revenues to interstate and international telecommunications,
and thus there is uncertainty for both providers and administrators.
This is not a trivial problem. With more than 40% of residential customers now
purchasing bundled services (and many business customers obtaining complex
bundles of services or bandwidth),51 it is no longer a simple task to identify interstate
and international telecommunications revenues. The federal Universal Service
assessment on interstate and international revenues for the first quarter of 2004 is

8.7%.52 Providers usually choose to recover this cost directly from their customers,


who would prefer to avoid the assessment. Providers therefore have the incentive to
offer their bundled service offerings in a fashion that allows them to minimize the
portion of the bundled price attributable to interstate and international
telecommunications. Reporting and auditing the interstate and international
telecommunications portion of provider revenues is a difficult task.


50 The Communications Act, as amended, in Section 254(d) requires “Every
telecommunications carrier that provides interstate telecommunications services shall
contribute, on an equitable and nondiscriminatory basis, to the specific, predictable, and
sufficient mechanisms established by the Commission to preserve and advance universal
service.” 47 U.S.C. § 254(d). In Texas Office of Public Utility Counsel v. FCC, 183 F.3dth
393 (5 Cir. 1999), the Fifth Circuit overturned an FCC order assessing intrastate as well
as interstate telecommunications to fund the schools and libraries portion of the federal
Universal Service Fund, but upheld assessing international telecommunications revenues.
51 According to the J.D. Power and Associates 2003 Major Provider Business
Telecommunications Services Study press release, “More Business Data Customers Willing
to Switch Telecommunications Providers in Favor of Cost-Saving Bundles,” October 2,
2003, at p. 1, posted on [http://www.jdpower.com/news/releases/index.asp], “The study
finds that the intention to switch providers to bundle multiple telecommunications services
is up 14 percentage points among broadband business customers to 43 percent overall.”
52 “Proposed First Quarter 2004 Universal Service Contribution Factor,” FCC Public
Notice, released December 4, 2003, at p. 1.

At the same time, as shown in Table 2, the Universal Service assessment base
– total interstate and international telecommunications end-user revenues less certain
exempt international revenues – has been declining as e-mail and instant messaging
increasingly substitute for long distance calling and as long distance rates continue
to fall.53 Although data are not yet available for 2003, it is likely that the assessment
base continued to decline in 2003 and continues to decline today as far more
customers that are high users of interstate and international service have shifted to
bundled service offerings with unlimited usage or high usage levels at flat rates that
have continued to fall.
Table 2. Universal Service Assessment Base: Total Interstate
and International End-User Revenues Less Certain
Exempt Revenues
(in billions)
YearTotal Interstate and International End-User Revenues
Less Certain Exempt Revenues
2002$76.285
2001$78.461
2000$78.977
Source: 2002: Federal-State Joint Board Monitoring Report, released December 2003,
Table 1.9, Preliminary 2002 data, at p. 1-32; 2001: Federal-State Joint Board Monitoring
Report, released December 2003, Table 1.4, at p. 1-17; 2000: Federal-State Joint Board
Monitoring Report, released October 2002, Table 1.4, at p. 1-16.
As interstate and international telecommunications revenues have begun to fall,
and as bundling makes it increasingly difficult to identify and assess those dwindling
revenues, many observers are concerned that interstate and international
telecommunications revenues no longer provide a sufficient – and sustainable –
universal service funding assessment base, as required by the Communications Act.54
The FCC first issued a Notice of Proposed Rulemaking to address this concern in
May 2001,55 and has subsequently issued additional notices and orders, but to date
has taken action only on a few narrow issues. In one action, as mobile wireless
telephone service, which typically is offered for a flat rate, has come to be used


53 The universal service assessment base is total interstate and international end-user
revenues less three exempt categories: revenues for international-to-international service,
international revenues where interstate toll represents less than 8% of the company’s
combined interstate and international revenues, and interstate and international revenues for
2,570 filers who are de minimis and thus not required to contribute. These three categories
of exemptions represent approximately 3% of total interstate and international end-user
telecommunications revenues.
54 Section 254(b)(5) of the Communications Act, as amended, lists as a principle that
“There should be specific, predictable and sufficient Federal and State mechanisms to
preserve and advance universal service.” 47 U.S.C. § 254(b)(5).
55 In the Matter of Federal-State Joint Board on Universal Service, Notice of Proposed
Rulemaking, CC Docket No. 96-45, released May 8, 2001.

increasingly for long distance calls, the Commission has increased the “safe harbor”
portion of revenues that mobile wireless carriers can attribute to interstate and
international calls from 15% to 28.5%.56 The FCC has been partially constrained in
its ability to address the issues relating to bundling and the sufficiency of the
Universal Service funding mechanism by the language in the Act and by the Fifth
Circuit decision.57 Some parties have claimed that alternative funding mechanisms
would not meet the statutory requirements as interpreted by the court, and that
Congressional action would be needed to implement these options.58
Three options have been proposed to address the issues of bundling and the
sufficiency of the Universal Service funding mechanism: expanding the assessment
base to include intrastate as well as interstate and international telecommunications
services, replacing the current mechanism with a capacity-based assessment on all
interstate connections to the public network, and replacing the current mechanism
with an assessment on all telephone numbers.
The option to expand the assessment base to include intrastate as well as
interstate and international telecommunications services would significantly expand
the assessment base,59 but would only address the reporting and auditing problems
created by those bundled service offerings that consist entirely of telecommunications
services. It would not address how to attribute the revenues from the interstate,
international, and intrastate telecommunications portion of a bundle sold at a flat rate
that also includes information services, such as high-speed Internet access, video
services, or equipment. Many business customers purchase a fixed amount of
bandwidth that they use to provide a wide variety of services – voice, data, Internet
access, video conferencing, etc. Currently, many bundled residential offerings that
include both telephone service and other services have separate prices for the non-
telephone services. But providers will have the incentive to reduce the portion of the
bundle subject to the Universal Service assessment on telecommunications services.
One way to do this is to simultaneously lower the rate for the telecommunications
portion of the bundle and raise the rate for the non-telecommunications portion, but
tie the former to the latter so that customers who do not purchase the non-
telecommunications services cannot take advantage of the lower telecom rate.
Another way to do this is simply to set a single rate for the bundled
telecommunications and non-telecommunications services, with the provider


56 “In the Matter of Federal-State Joint Board on Universal Service, Report and Order and
Second Further Notice of Proposed Rulemaking, CC Docket No. 96-45, released December

13, 2002, at p. 14.


57 See footnote 50 above.
58 See, for example, the Comments filed on June 25, 2001 by Verizon and by the United
States Telephone Association, responding to the FCC’s May 8, 2001 Notice of Proposed
Rulemaking in In the Matter of Federal-State Joint Board on Universal Service, CC Docket
No. 96-45.
59 Total End-User Revenues from local service, wireless service, and toll service in 2001,
the latest year for which data are available, were $235.5 billion, $155.3 billion of which
were intrastate, according to the FCC’s Annual Trends in Telephone Service, Table 15.1,
“Telecommunications Industry Revenues: 2001,” (released in August 2003) at p. 15-3. This
report is available at [http://www.fcc.gov/wcb/stats].

determining the portion to be attributed to telecommunications services and thus
subject to assessment. Given the Fifth Circuit decision, a statutory change would be
required to allow the FCC to impose a Universal Service assessment on intrastate as
well as interstate and international telecommunications revenues.
The option to implement a capacity-based assessment on all interstate
connections to the public network would avoid the reporting and auditing problem
that currently exists for bundled service offerings because it would be based solely
on the capacity of each end-user customer connection to the public network. The
FCC, with guidance from Congress, could set assessment rates by weighing various
public policy considerations to determine, for example, whether, in order to foster
broadband deployment, the assessment on high-speed connections (at least for
residential customers) should not be set higher than that on standard voice
connections, or whether, for equity reasons, there should be a lower assessment for
voice grade connections than for high-speed connections. Also, since all end users
ultimately must connect to some network to communicate – no matter what
technology they use – the assessment base will be sustained over time. A capacity-
based assessment on all connections would be simple to implement and administer
for residential customers, but far more difficult for business customers, who use
many different connection configurations. Some parties have argued that a
connection-based approach would require a statutory change because some interstate
carriers do not offer connections and thus such a charge would not meet the statutory
requirement that all interstate carriers contribute to the fund on an equitable and
nondiscriminatory basis.
The option to implement an assessment on all telephone numbers also would
avoid the reporting and auditing problem that currently exists for bundled service
offerings because the assessment would be based solely on the number of telephone
numbers provided to customers. With each telephone number given the same weight,
this approach would treat more intensive and less intensive users of the public
network exactly the same. But there are so many telephone numbers that the
assessment per telephone number is likely to be relatively small. It is possible that
a massive move to Internet protocol technology could result in many parties using
“addresses” other than the traditional telephone number, but presumably in that case
there would be a way to assess the new address; some sort of address will always be
needed in order to direct communications from a sender to a receiver. Since some
interstate telecommunications carriers do not provide telephone numbers, some
parties have argued that a statutory change would be required to implement a
telephone number-based universal service assessment mechanism, unless a hybrid
assessment mechanism were created that assessed on the basis of revenues those
providers of interstate services that do not use numbers. Such a hybrid solution
might not eliminate the need for a statutory change, however, if the interstate services
provided by those carriers are bundled in a fashion that makes it difficult to identify
unambiguously the interstate and international revenues generated.
Currently, no bills have been introduced in Congress that directly address the
issue of the federal Universal Service assessment base. Both Section 3 of S. 1380,
the Rural Universal Service Equity Act of 2003, and Section 4 of H.R. 1582, the
Universal Service Fairness Act of 2003, would require the Comptroller General to
submit a report to Congress on “the need to reform the high-cost support mechanism



for rural, insular, and high cost areas,” including a discussion of whether
“amendments to section 254 of the Communications Act of 1934 (47 U.S.C. 254) are
necessary to preserve and advance universal service.” Section 4 of S. 150, the
“Internet Tax Non-discrimination Act of 2003, states that “Nothing in the Internet
Tax Freedom Act shall prevent the imposition or collection of any fees or charges
used to preserve and advance Federal universal service or similar State programs
authorized by section 254 of the Communications Act of 1934.”
Bundling and Taxes
In addition to the federal Universal Service Fund, there are a number of taxes
that are assessed on one or more, but not all, of the services included in various
bundled service offerings. This creates the same assessment and auditing problem
for these taxes as exists for the federal Universal Service Fund.
In particular, many state and local jurisdictions assess taxes on telephone and/or
video services. How should those taxes be assessed on bundled services offered at
a flat-rate that include telephone service and high-speed Internet access service or
cable service and high-speed Internet access service? How can providers identify and
report, and state and local tax collectors audit, the taxable portion of such bundles?
The Internet Tax Freedom Act moratorium on taxing Internet access (P.L. 107-75)
has expired. S. 150, S. 52, and H.R. 49 would make the moratorium permanent; H.R.
1481 would extend the moratorium until 2008. Since it is likely that Internet access
services increasingly will be bundled with other services that are subject to local or
state taxes, if the Internet tax moratorium is extended the challenge of appropriately
assessing and auditing these taxes will grow.
Bundling and Competition
Some observers have been concerned that bundled service offerings could have
anticompetitive consequences if they foster industry consolidation or if a provider has
market power for one of the services in its bundled offering and can use that offering
to tie that service to a competitive service in a fashion that reduces competition for
the competitive service.
Although it is too early to determine which providers ultimately will benefit
most by the trend toward bundled service offerings, the early market results suggest
that the ILECs have been more successful at capturing long distance customers than
the long distance companies have been at capturing local customers. Despite the fact
that the long distance carriers had been able to offer bundles of local and long
distance services for months or even years before some of the Regional Bell
Operating Companies (“RBOCs”) received FCC permission to offer long distance
service within their services areas, the RBOCs have captured four long distance
customers for every local customer captured by the long distance carriers, as shown
in Table 3.



Table 3. “Non-traditional” Customers Captured by Local and
Long Distance Carriers
Traditional LocalLong DistanceTraditional LongLocal Customers
CarrierCustomersDistance CarrierCaptured
Captured
Verizon15.9 millionAT&T3.5 million
SBC11.5 millionMCI3.5 million
BellSouth3.4 millionSprint0.2 million*
Source: Griff Witte, “An Evolutionary Edge: Local Phone Firms Pass Long-Distance
Companies,” Washington Post, December 3, 2003, at p. E1. All data provided by the
companies. Numbers for traditionally local companies include a limited number of business
customers. *Sprint also has 5.3 million local customers in the various territories where it
also is the incumbent local exchange carrier.
According to a J.D. Power and Associates consumer survey, 40% of the
respondents stated they would most likely choose their local telephone company to
provide bundled services, 21% would most likely choose their long distance60
company, and 16% their cable company. According to company officials, Verizon
now has signed up more than 50% of its local residential customers in some states
for long distance service; by contrast, AT&T has signed up at most 15% of its
customers to local as well as long distance service.61 According to Kate Griffin, a
senior analyst with the Yankee Group, “The local providers have an edge. The local
relationship is worth more. Customers are more likely to look to the local provider62
for that bundled offering.”
It may be too soon to conclude how this competition will play out, however.
The RBOCs’ success may be explained in part by the fact that for more than 20 years
residential customers have been choosing among competitive long distance carriers
and thus they are not reluctant to switch to their ILEC when that ILEC begins to offer
long distance service. On the other hand, residential customers for the first time can
choose their local provider and perhaps many simply are not yet ready to change their
behavior. As explained earlier, bundles appeal primarily to heavy
telecommunications users. Heavy long distance users already are used to choosing
among – and changing – carriers. Heavy local users, however, are just becoming
accustomed to choice in local service. Also, local service provides the “lifeline” to
the outside and thus customers may tend to be more cautious about leaving their
traditional local provider. This pattern may change as customers become used to


60 J.D. Power and Associates 2003 Residential Long Distance Service Study press release,
“Customer Satisfaction Increases as Stiff Rate Competition and Bundling Cause Steep Drop
in Long Distance Spending,” July 1, 2003, at pp. 1-2, posted on [http://www.jdpower
.com/news/releases/index.asp].
61 Griff Witte, “An Evolutionary Edge: Local Phone Firms Pass Long-Distance
Companies,” Washington Post, December 3, 2003, at p. E1.
62 Ibid at p. E1.

having local as well as long distance options. Moreover, as local and long distance
telephone services become elements of larger bundled offerings that include wireless,
video, high-speed Internet access, and other services, the competitive options
available to consumers increasingly will come from non-wireline providers.
If there still are impediments to the competitive provision of one of the services
included in a bundled offering, however, bundling could allow those providers that
are not constrained by those impediments to extend their market advantage beyond
the market for that particular service into the markets for the other services included
in the bundled offering. According to a study performed by a coalition of small
CLECs,63 the RBOCs have a 61% share of the customers currently using bundled
service offerings that include both local and long distance service, and 80% of the
remaining customers for bundles that include local and long distance service are
served by the unbundled network element known as the platform (“UNE-P”) leased
from the RBOCs.64 Under current conditions, if CLECs were to be denied access to
UNE-P to offer local residential service, many would not be able to compete with the
RBOCs for the provision of bundled local-long distance service. Given the
popularity of such bundled services, this likely would allow the RBOCs to extend
their advantage in the local market (by dint of their historical position as the
monopoly providers with ubiquitous local networks) into the long distance market.
Any harm to consumers from lack of competitive choice might be ameliorated,
however, by the extent to which other providers could enter to offer bundled local
and long distance service. For example, cable companies or other potential
competitors could use voice over Internet protocol (VoIP) to offer competitive
bundled local-long distance service. Such service may require a customer to have
high-speed Internet access, but the high-usage customers most attracted to bundled
services often are the consumers most likely to have high-speed Internet access.
A number of CLECs and CLEC customers have brought antitrust suits against
RBOCs, alleging that the RBOCs violated the antitrust laws by not making their
unbundled network elements available in a timely and viable fashion.65 The U.S.
Supreme Court, however, ruled on January 13, 2004, in Verizon Communications
Inc. v. Law Offices of Curtis V. Trinko, LLP,66 that failure to meet the unbundling


63 “Measuring RBOC Dominance of Bundled-Services: The Progress of Competition
Under the New Social Contract,” an undated report of the PACE Coalition (a coalition of
small CLECs) prepared in late 2003, at p. 3, posted on [http://www.pacecoalition.com],
viewed on 2/10/2004.
64 The PACE report claims that only 1% of these customers are served by wireless
providers. This suggests that the PACE Coalition only included those wireless customers
who have abandoned wireline service entirely and use wireless service as their exclusive
provider of local and long distance service.
65 For example, Trinko and Cavalier brought cases against Verizon, Covad brought a case
against BellSouth, and Metronet brought a case against Qwest.
66 Verizon Communications Inc., Petitioner v. Law Offices of Curtis V. Trinko, LLP,
Supreme Court of the United States, 540 U.S. _____ (2004), January 13, 2004, Slip opinion
at 6-7 (2004 WL 51011). For a more complete discussion of the Trinko decision, see CRS
Report RS21723, Verizon Communications, Inc. v. Trinko: Telecommunications Consumers
(continued...)

requirements in the 1996 Telecommunications Act, which were intended to foster
competition by aiding competitors, does not meet the pre-existing antitrust standards,
which relate only to acts that would lessen competition, and thus does not represent
an antitrust violation. To the extent that access to UNEs are needed for the
competitive provision of bundled service offerings, then, oversight can only be
performed by federal and state regulatory agencies, not by the antitrust authorities.
Bundling also could affect the competitive environment if it provides a vehicle
for a provider with some market power in the market for one of the bundled service
elements to price in a fashion that undermines competition in the market for other
services in the bundle. Dominant firms typically are constrained in their ability to
practice predatory pricing or other potentially anticompetitive types of strategic
pricing against new entrants because it is very difficult to introduce selective price
cuts for those customers they want to keep away from competitors without giving the
same price discount to a large portion of their customer base. This could so dilute
revenues and profits in the short term that such losses could not be recouped in the
long term even if competitive entry were retarded or entirely eliminated. To the
extent a dominant provider attempting to fend off competitive entry could limit the
price cuts to those customers most likely to shift providers and to a limited period of
time, the potential for anticompetitive predatory or strategic pricing increases.
Bundling might be a tool that could facilitate this.
For example, observers have speculated that cable companies, which are the
largest providers of high-speed Internet service, might be able to impede ILEC entry
into that market by selectively reducing prices for their cable modem services when
ILEC entry is imminent. Such concern was kindled recently when Comcast made a
targeted e-mail offer to certain customers in California, Maryland, and Illinois, for
cable modem service at $19.95 per month for a year.67 After the promotional period,
the price goes back to $42.95. Comcast executive vice president for marketing Dave
Watson stated that “This highly targeted e-mail offer is a test campaign aimed
directly at DSL customers. It is similar to other win-back-type programs we’ve
conducted in the past. This particular campaign is a limited offer and we anticipate
it to be a one-time event as other offers of shorter duration such as 6 months have
proven successful.” But if Comcast (or any other provider of high-speed Internet
access service or any other service that is part of a bundled service offering) has the
ability to selectively restrict price cuts to those customers most likely to shift to a
competitor and to the time period when a competitor is entering the market, some
observers say, then there is at least some potential for that dominant firm to
strategically restrict competition in the market even if it is not practicing predatory
pricing. The lower prices benefit the selected customers in the short run but can be
harmful to the public if they successfully forestall competitive entry. Consumers
would then be denied the competition-driven benefits of lower prices and more
innovation in the long run.


66 (...continued)
Cannot Use Antitrust Laws to Remedy Access Violations of Telecommunications Act.
67 Communications Daily, November 17, 2003, at p. 7.

Another potential competitive consequence of the trend toward bundled service
offerings is the incentive created for firms to consolidate in order to more efficiently
provide broad bundled offerings or to deny competitors access to independent
providers of services needed to offer a complete bundle of services. As explained
earlier, consumer preference for larger bundled offerings tends to favor large
companies able to offer all or most of the services in the bundle on their own, without
reliance on independent entities. But no provider today has the capability of
providing all these services. This has fostered marketing agreements and other
relationships, which could be a precursor for more formal ownership consolidation.
Such consolidation potentially reduces administrative and coordination expenses.
But such consolidation also potentially locks up suppliers.
For example, consider the strategy of bundling wireline and wireless service
discussed in the section on Wireline, Wireless, and Video Bundling Strategies. The
three largest ILECs, Verizon, SBC, and BellSouth, each have large equity interests
in wireless carriers, and each have bundled offerings that combine wireless and
wireline service. Other wireline carriers face strong market pressure to offer bundles
of wireline and wireless services as well. AT&T has a pilot program to offer bundled
service in conjunction with AT&T Wireless, which had been part of AT&T but now
is independent. AT&T Wireless, however, has announced that it is accepting
Cingular’s bid to acquire AT&T Wireless. For Cingular, and its parents, SBC and
BellSouth, acquisition of AT&T Wireless would provide economies of scale and
needed spectrum in large markets such as New York where Cingular has limited
spectrum. In addition, such a purchase would take away from AT&T an independent
source of wireless service and perhaps make it more difficult for AT&T to offer a
bundle that includes wireless service.
Conclusion
The bundling of residential telephone, Internet, and video services has been
warmly welcomed by consumers. It allows providers to reduce costly customer
churn and exploit marketing efficiencies that they have passed through to consumers
by lowering rates. But bundling represents a strategic response to the convergence
of previously distinct markets and that convergence is creating the need to review
current telecommunications law and rules. Leaders in both the House and the Senate
Commerce Committees have indicated that review and reform of the 1996th
Telecommunications Act will be on the agenda in the 109 Congress. Major issues
that are likely to be addressed include creation of a sufficient and sustainable funding
mechanism for the federal Universal Service Fund as interstate telecommunications
revenues continue to decline (and become increasingly difficult to identify as
bundling proliferates), the proper regulatory treatment of services that are provided
by different underlying technologies but compete with one another, and the best
regulatory framework for fostering innovation and investment while safeguarding
consumers and competition. All three of these issues are likely to be affected by the
deployment of Voice over Internet Protocol (VoIP) technology, which already has
begun to occur.