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Cover Story: TELECOM'S NEW AGE

SHOWTIME FOR THE WATCHDOG

Now, the FCC must set the rules for reform

As the telecom reform act ushers in an era of freewheeling competition, federal regulation will fade away, right? Wrong. The Federal Communications Commission's legions will be busier than ever writing the rules to implement the law's sweeping changes and create a smooth glide path to full competition. "This is the most intense and important time in the FCC's 62-year-old history," boasts its chairman, Reed E. Hundt.

The agency wound up with this huge role in part because of the drawn-out legislative process that produced the bill. In order to get telecom reform passed--after 10 years of trying--Congress booted many of the thorny details to the FCC. For instance, News Corp. Chairman Rupert Murdoch and his fellow broadcasters tried last year to stop Congress from closing a loophole that let the broadcasters get around limits on station ownership. That issue was such a hot potato that it might have tied up the entire bill. Now, it's in the hands of the commission.

There are dozens of other unresolved issues the FCC will address--and in doing so, shape policy. "What they do will determine the future of competition in communications," says Leon M. Kestenbaum, vice-president for federal regulatory affairs at Sprint Corp. The states have a role, such as overseeing local rates and verifying that the Bells comply with a checklist of conditions to prove their networks are "open." And the Justice Dept. will be looking at possible antitrust issues. But the big questions of the moment will go to the FCC. "The FCC has become the new battleground," says Columbia University economics professor Eli Noam.

The No.1 issue will be introducing competition into local calling. The agency must rejigger a patchwork of subsidies that have been used to ensure "universal" local service. Phone companies usually charge high rates to businesses--to keep residential rates low. But with rivals gunning for business customers, local companies can't be expected not to cut business rates. The law calls for the FCC to implement a subsidy pool that will be used to pay for cut-rate service to poor and rural customers. But the FCC must figure out who pays and what services should be subsidized: just dial tone--or computer links to schools, too?

DEGREES OF SEPARATION. At the same time, the agency must develop rules that give new local players a fair shot against existing monopolies. Many entrants into local calling will start by reselling capacity from existing carriers--rather than building their own networks. How much the incumbent phone company charges will be up to the FCC. The law defines the wholesale price as "retail less avoided costs"--what the local company doesn't pay in marketing, customer service, and billing when dealing with resellers. But how much are such costs? The Bells say they're minimal because they want to charge as much as possible. The local upstarts, including AT&T, MCI Communications, and Sprint, argue that avoided costs are quite high--justifying lower rates to them.

The FCC must also figure out how to "unbundle" local phone service. In the past, the Bells effectively barred resale by bundling all services together. For example, they would force rivals to buy switching as well as capacity, even if all they needed was capacity. That made resale unprofitable. The new law requires local carriers to price services separately, but the FCC decides how. The Bells want the FCC to allow them to factor in costs such as depreciation. Rivals want to pay only for the actual cost of the services.

Some new entrants may choose to build their own networks. For them, the FCC must figure out rules for interconnecting with existing local networks. The new law "is ambiguous on this issue," says Heather Burnett-Gold, president of the Association for Local Telecommunications Services. It says rivals should be able to connect at "any technically feasible point." How the FCC clarifies that issue could have a big effect on the costs of interconnecting.

The commission is also working on more than 18 new cable rules. Under the new law, all rate regulation will be removed in 1999. If a cable operator wants to be free earlier, it must show the FCC that there's "effective competition" from at least one rival. Right now, the FCC defines that to mean a rival can reach 50% of a market and has 15% of potential customers. Congress has the FCC examining that rule. The cable industry wants the numbers halved or dropped. Phone companies and other cable rivals want them left as they are.

BOX BATTLE. Cable companies are also watching how the FCC rules on cable-converter boxes. It's up to the FCC to determine whether they will be sold, the way phones are, or simply leased, as they are now. In Congress, electronics retailers such as Circuit City Stores Inc. lobbied for box sales. But the prospect upsets cable operators, which reap big profits on rentals. Box makers also fight the notion of selling--because it might require the industry to settle on a universal standard. That would make it possible to move boxes between systems but might complicate plans to upgrade networks, argue box makers. Retailing "would be a serious problem for the industry," says General Instrument Corp. Chairman Richard S. Friedland.

While the FCC is working through all these issues, Congress will be watching. And once the new regs are written, chances are lawmakers will consider downsizing the agency. But for now at least, the FCC's Hundt doesn't have time to worry about the future. He's too busy launching the deregulation that could seal the FCC's fate.By Mark Lewyn in Washington


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