Call classification, the achilles heel of PSTN deregulation

Fred Goldstein,  August 2003


...long distance calls have long subsidized local service, especially in rural areas where local telephone lines are particularly expensive to provide...


...Local calling areas, after all, are merely a tariff artifact, a retail pricing technique.  They have no basis in cost....

...they seek to classify CLEC-bound calls as toll, so that they can be on the receiving, rather than sending, end of the payment stream for calls they send to CLECs...

...MCI's alleged misrouting of calls is an example of the risks of call classification...

Americans are accustomed to having a distinction between "local" and "toll" calls.  In almost all of the country, residential telephone subscribers are allowed to make as many local calls as they want at no charge -- a true flat rate. But they're accustomed to paying by the minute for toll calls. This retail pricing distinction goes back to the early years of telephony, and while there are those who argue that all calls should cost the same, for so-called postalized rates, there are plenty of reasons for distinctions to remain.  Internet backbone providers haven't exactly made great profits out of their postalized rate structure!  And  don't even think about the hue and cry that has come up every time a telephone company has proposed abolishing flat rate local service.

But a cost-justified distinction between different types of retail rates, or for that matter a cost-justified distinction in wholesale inter-carrier rates, is not the same as the current system. As a result of a long chain of federal and state regulatory decisions, telephone calls are subject to an arbitrary system of classification, in which rates are based on rather historical "value of service" constructs.  This was workable during the monopoly era, when there were no alternatives, but it's causing far more harm than good today.

Exchange vs. toll

The Telecommunications Act of 1996 made substantial changes in the structure of the industry, but some were rather subtle.  It did not, alas, do away with arbitrary call classification.  Instead, it divided telephone calls into two categories, telephone exchange service and exchange access.  Telecom lawyer Chris Savage has noted, "Under the 1996 Act, a service is "exchange access" only if it is used for the origination or termination of 'telephone toll service,' another defined term in the Act."  Telephone toll service applies when the carrier levies a toll charge for making calls. Other calls are, by the plain language of the Act, telephone exchange service.

When newly-minted CLECs started picking up calls directed for ISPs in the 1990s, the incumbents balked, since the way CLECs and ILEC pay each other is based upon what type of call it is.  For telephone exchange service, the originating local carrier pays reciprocal compensation to the terminating carrier.  For exchange access, the interexchange carrier pays switched access, and pays it to the originating carrier.  In effect, exchange access calls are originated "collect".  Since ISP-bound calls aren't charged tolls, the originating ILECs couldn't legally charge switched access, although they sometimes tried, and continue to try.  (ILECs are nothing if not trying.)  But an ILEC-friendly FCC in 2001 decided to discover a third category of calls, information access, hidden in a section of  the Act that almost anyone else would read to refer to things like 900-number calls.  And thus exempted the ILECs from paying CLECs for calls classified as ISP-bound.  To be sure, this gambit hasn't exactly been blessed by the relevant courts, but it remains in effect for the foreseeable future.

The particular classification of calls as local or toll, telephone exchange service vs. exchange access, has two rational motivations behind it.  For one thing, long distance calls have long subsidized local service, especially in rural areas where local telephone lines are particularly expensive to provide.  Thus switched access rates in rural areas can be as much as an order of magnitude higher than in urban (Bell) areas.  This is part of the industry's cross-subsidy structure, along with explicit High Cost Support payments from the FCC-overseen Universal Service Fund. A second rationale is that the IXC, not the originating LEC, has the billing relationship with the caller, and thus is the logical one to pay for the originating leg of the call.  (They pay for the terminating leg too, but because the IXC is the caller, that leg of the call is sent paid, and thus the only issue is price, not who pays whom.)

The 1984 restructuring of the domestic telephone industry created a Chinese wall between the local and long distance industries, with these access charge payments an integral part of the scheme.  The Telecom Act of 1996 allowed the players on each side to enter each others' markets, but it did not remove the distinction between the IXC and LEC roles.  ILECs who provide LD services are still required to maintain accounting separation between the two lines of business, and deal at arms' length.  Albeit very short arms, at this point.

The problem is most serious within a LATA

Call classification causes the most grief when applied to intraLATA calls, especially between CLECs and ILECs.  In such cases, there is no IXC present, so the calls could rationally be handed off on a reciprocal compensation basis, like any other local call.  Local calling areas, after all, are merely a tariff artifact, a retail pricing technique.  They have no basis in cost, and local interconnection in general is theoretically based on cost, not retail pricing.  The problerm is that most ILEC-CLEC interconnect agreements (ICAs) require the originating carrier to pay intrastate switched access rates on calls sent to destinations that are outside of the ILEC-defined local calling areaSwitched access rates are often much higher than reciprocal compensation; intrastate switched access rates are also often much higher than corresponding interstate rates.  (Reciprocal compensation is moving towards zero, as the FCC encourages "bill and keep" as the long-term solution to the "ISP problem".)  So the CLEC cannot offer an enhanced local calling area unless it eats the terminating access charges.

But sometimes it gets even worse than that.  ILECs are so accustomed to feeding at the access charge trough that they even want to collect these charges from CLECs for inbound calls.  That is, they seek to classify CLEC-bound calls as toll, so that they can be on the receiving, rather than sending, end of the payment stream for calls they send to CLECs. This is done by narrowing the qualifications for a call to be classified as local, and assuming that a call must otherwise be toll, or at least subject to access charges.

They attempt to justify this in various ways, typically taking advantage of the differences in ILEC and CLEC network architectures.  ILECs used to put switches at every wire center, and defined local calling areas based on having direct trunks between these switches.  Nowadays, ILECs typically serve rural areas with host-remote clusters, with the trunks concentrated at the host. Retail tariffs don't take this into account.  A CLEC has to interconnect with the serving tandem, and sometimes with the host, but essentially never with the remote.  CLECs have fewer switches, and they almost never have copper loops directly connected to them; one CLEC switch typically services a large geographic area, like an ILEC host or tandem. 

ISP modems are usually collocated with CLEC switches.  This is purely pragmatic.  A modem bank essentially compresses bandwidth by about 10:1, since a modem channel into the switch is 64000 bits per second and the average data usage of a modem is more like 6000 bits per second.  The ISP would need ten times the bandwidth from the CLEC to its site if it were to have its modems on site, vs. collocating them with the CLEC and just forwarding the data.  ILECs, as a general policy, do not allow modems to collocate at their central offices.

So rather than accept this as a competitive advantage of CLECs, or (heaven forbid!) become more competitive by allowing ISPs to collocate, ILECs have taken to attacking CLEC-collocated modems as being toll calls, not local!  This can happen when the switch, and thus the modem, happens to not be within the ILEC's own local calling area.  For instance, the CLEC may have its switch in Dallas, but use it to service Fort Worth and Waco numbers as well.  It's no additional cost to the ILEC if the ISP's modems are at the CLEC switch, but they use this as a competitive weapon for their own captive ISPs, and just maybe (this is far-fetched, given market realities) as a source of future toll revenues.

Gaming the system or just plain cheating?

The recent brouhaha concerning concerning MCI's alleged misrouting of calls is an example of the risks of call classification.  Several companies, including SBC, Verizon and AT&T, allege that MCI passed off toll calls as local as a way to avoid switched-access charges.  From my own experience, this is credible.  I've received calls placed by MCI subscribers whose Caller ID was erroneous. Instead of showing the caller's out-of-state number, the Caller ID identified a local number.  The local number was in a block belonging to CLEC Focal Communications.  This implies that MCI did not terminate the calls directly into the LEC network as switched access, but instead re-originated the calls, using Focal-provided lines, as if they were locally originated.  (Doing this on lines that showed Caller ID was astonishingly stupid.  If you're going to cheat, even on a stupid rule, you're a fool to do it so openly.  MCI Worldcom had plenty of local switches of its own that could be set to show "out of area".)

The reason that this matters at all is because switched access charges, while much lower than they once were (at their peak in the 1980s, around eight cents at either end in Bell areas, more elsehwere; today they're under a penny a minute in Bell areas), they're still a major part of long distance company expenses.  Verizon's own business-rate local service in Boston costs more than switched access, at 1.7 cents per minute!  But because the ILECs objected to reciprocal compensation after discovering themselves to be at the losing end of it, CLECs are now being moved towards bill-and-keep for local calls.  So a local call through a CLEC often costs nothing. 

But as a result of classification, it gets worse.  If the CLEC has a lot of incoming ISP traffic, then the FCC's current rules encourage even more egregious gaming.  Traffic is generally assumed to be ISP-bound, a classification that carries no reciprocal compensation, if it is more than 3:1 out of balance. With no outbound traffic, no inbound reciprocal compensation is due. So if a CLEC receives 10 million minutes a month from Verizon and only sends Verizon 1 million local minutes, then  the CLEC receives a net reciprocal compensation settlement of 2 million minutes (7 million minutes are assumed to be ISP-bound, 3 million allowable inbound vs. 1 million out).  Get it?  Now, if the CLEC originates an additional 2 million minutes, it receives a net setlement for 6 million minutes!  The CLEC essentially gets paid to originate calls, unitl it gets to its 3:1 ratio. No wonder Focal and MCI were such a match.

A more rational system would be for all intercarrier interconnection to be at cost-based rates.  The LEC would be paid the same for its part of a "local" (reciprocal compensation) or "toll" (switched access) call.  Implicit subsidies from higher-than-cost switched access would be moved to the explicit Universal Service Fund, collected on a broader base of revenues.  LECs would set their own local calling areas.

The FCC has been afraid of an unclassified system of interconnection, even though it is widely used in Europe and elsewhere.  The current classification-based subsidy mechanisms have too many influential carriers, their lobbyists and their lawyers supporting them.  But call classification remains a major impediment to a true competitive market for telecommunications service.