June 1998

BY EVAN KOBLENTZ

Dollars and politics precede technology issues in the universal service debate, but now, a semantic battle is the top priority: defining "carrier" in the telecommunications sense is the billion-dollar question.

THE UNIVERSAL SERVICE FUND
All interstate telephone carriers must contribute to the Universal Service Fund (USF), as ordered by the 1996 Telecommunications Act. Currently, IP telephony providers are not legally considered carriers -- they currently fall under the "information services" definition, which are fund-exempt under the 1996 act. Regardless of Congress' eventual interpretation of that point, IP telephony firms and conventional carriers both seek federal mercy, the former from carrier status and the latter from coping with the fund solo. Telephony is a young industry, but most parties involved agree that the battle seeds date to at least the 1934 Communications Act.

Wide-Spread Assumptions
When that act debuted, Americans made two assumptions. The first was that among calls of the same duration, it costs more for the telephone company to place the one to a further-away location. The second is that it is the government's duty to support telephone service in rural, isolated, and low-income places, to create "universal service," in areas which industry may not otherwise touch. To the average Depression-era American, both made sense.

Today, industry insiders know that the first one just isn't true. Long distance calls do cost more, but that's because of regulation, not technology. Congress and the FCC decided during the 1984 AT&T break-up that local carriers can charge outsiders for using their networks, but they can only charge other voice carriers, not end users. Long-distance carriers and resellers bear the majority of these access fees, which they recollect by increasing end user long-distance prices. Meanwhile, as mandated by the 1996 act to reform high-cost support, the FCC established a new "Universal Service Fund" in May 1997, which took effect in January 1998, and which gets its money from a portion (just under 4 percent) of all interstate carriers' revenue. Today's USF does more than its 1934 roots, also funding high-cost school and health-care telecommunications needs. It is a big portion: a FCC spokesman who requested anonymity put the carriers' slice at about half of the USF, but that official's estimate of a $1.5 billion fund is low compared to some industry estimates of a $5 billion fund, money that goes toward the above-mentioned high-cost groups. New and old style carriers alike are learning that whether or not this system works depends on whom you ask.

History Of Universal Service
Before considering Congress' definition of "carrier" in the 1996 act, consider the history of universal service. Since the FCC's creation with the Communications Act of 1934, and continuing from the 1984 Ma Bell issue to the 1996 Telecommunications Act, there was no "universal service" fund: numerous state and federal subsidies combined with the costly access charges to support high-cost areas. But some such areas went overlooked, and nobody at the FCC will say on the record just how large the previous funds got -- industry estimates range from $3 to $25 billion. There's also little account for how many different subsidies there were or what portion of the funds came from subscriber line charges or per-minute access fees. Congress, for its part, decided that it was time for universal service reform. After hosting seven public hearings and soliciting a 70,000-page record plus testimony by more than 50 experts, Congress' actions via the 1996 act led to the January 1998 USF origination date. Despite this decision, the conventional carriers versus telephony industry battle continues to hinge on the "carrier" definition.

FCC'S RECENT REPORT
The latest round concluded on Friday, April 10 of this year, with the highly-anticipated FCC report to Congress. The report, via its suggested classification of IP telephony providers, was to help Congress determine whether to treat those providers like conventional carriers or to let them continue their unregulated course. The results cured nobody's anxiety: The FCC commissioners bargained for more time, but hinted that they may advise Congress to compromise, including only direct phone-to-phone IP telephony in the conventional carrier category (For excerpts of the ruling, see the sidebar entitled The FCC Report To Congress). Now, as Americans and the mainstream press begin to understand the industry and its implications, those with foresight huddle with their technology-enlightened brethren and wonder: What now?

Arguing For A Broader Definition
On the other side are Senators Rockefeller (D-WV), Snowe (R-ME), Stevens (R-AK), and Burns (R-MT), all representing states with strong rural areas. Speaking on behalf of Sen. Stevens before a FCC en banc hearing was attorney Earl Comstock, who noted "Congress did intend telecommunications service to describe a broader class of services in the Commission's pre-1996 Act definition of basic transmission service. The Commission has already recognized that to some degree, we would just urge that you go further. The Commission should interpret the definitions of telecommunications service and information service as overlapping or at least, at a minimum, move the demarcationpoint between them. To do otherwise would make a mockery of many provisions added by the 1996 Act.

"The Stevens report is not asking merely about the direct universal service fund. It is also inquiring about the Commission's exemption of ISPs from access charges. Including schools and libraries, the direct USF contribution is roughly five billion dollars per year. This pales beside the roughly 20 to 25 billion dollars in access charges that are collected from ISPs each year to support the cost of operating the local network at an affordable rate. Some portion of that 20 to 25 billion dollars goes to support universal service. The rest supposedly goes to pay for the use of the local network to reach individual homes and businesses. It is that network from the central office to the house that I think is often overlooked.

"This is not to say that ISPs should pay per minute access charges. Rather it is to say that some portion of the ISP traffic, that which also meets the definition of telecommunications, should be included in the pot when the FCC restructures access charges. We already collect enough money today, but that will not be the case in the future if traffic is removed from the pot by a technological slight of hand."

According to Bill Lehr, a Columbia University economics professor and consultant to the Internet Telephony Consortium, however, "Covering the cost of an infrastructure is largely the problem of the infrastructure." The system that the USF originates from, he said, "...really doesn't work in a multimedia world."

Don't Regulate The Internet
Contrasting Comstock's testimony were, among others, technology visionary Esther Dyson, author of Release 2.0: A Design For Living in the Digital Age and Jill Lesser, counsel for America Online, Inc. Lesser's comments came first: "Many recent studies whichwe reference in our written submissions highlight theextraordinary impact that the explosive growth of advanced services has had on the American economy.As the Commission recognized last year, thiscontribution to economic growth clearly would not have occurred had the Internet industry been hampered by burdensof telephone-like regulation or access charges.

"Indeed, the '96 Act was intended to diminishGovernment intervention in all communication sectors, not tobring new and innovative industry into the falls of an out-loaded regulatory regime designed for monopoly environments."

Dyson's comments also took the telephony industry's side: "What you're looking at here is not at a simple food chain where you can easily take out one segment and decide to tax it, but a very complex web. And so, my basic suggestions would be that you nottry to do that because any definition you make that tries todistinguish between one kind of operation or entity is goingto end up both being breached and arbitrary on the one side, and distorting the marketplace on the other.

"When you talk now about universal service funds...my short form version is that these areworthy goals, but I'm not sure how -- it seems to me thisstuff should be paid for by general taxes rather than out ofsome arbitrarily defined telecom pot...Ifwe do have a truly competitive environment, I believe priceswill drop so low that many of these questions will have muchless relevance."

Alternatives To The USF
Expert's testimony in these realms goes on, not just for that particular hearing but for published comments on universal service in general. Some parties have suggested alternatives to the USF entirely; most involve some form of general tax contribution to the nation's telecommunications infrastructure. To further complicate the matter, the current system will become obsolete on January 1, 1999, when the FCC begins funding the USF through a new economic model based on the "forward looking" cost of providing service to high-cost areas. August is the FCC-set deadline for determining that model.

Another new system will take effect for year 2000 and beyond. Meanwhile, the FCC has solicited state-defined plans for the potential models. After choosing the model to pay for the difference between the national average cost and the rural average cost of providing phone services, the FCC will pay 25 percent, and carriers and states will pay the remainder.

REGULATORY FUTURE
From the New York Times to PC Magazine to CNN, Internet telephony is beginning to spread its mission to the mainstream press, standing now where the World Wide Web stood in the early 1990s. Senators, representatives from high-cost locations, and conventional carrier executives flood the FCC from one side; everyone from Microsoft to Web philosophers to small telephony start-ups flood the FCC from the opposing angle. Stuck in its unenviable situation, the FCC merely deferred the inevitable -- regardless of their suggestions and Congress' actions on those suggestions, some industry will suffer. But as noted by one expert, telephones did not ruin the postal service, and television did not ruin radio. Now, Internet telephony's influence on the phone incumbents remains to be seen.

Evan Koblentz is a technology editor for CTI magazine.

The FCC Report To Congress

A hint of what may come: The following excerpts are from the FCC report to Congress on April 10, 1998 (we've added headings of our own for clarification). For a full transcript of the report, visit www.fcc.gov.

The Commission to date has not formally considered the legal status of IP telephony. The record currently before us suggests that certain "phone-to-phone IP telephony" services lack the characteristics that would render them information services within the meaning of the statute, and instead bear the characteristics of telecommunications services. We do not believe, however, that it is appropriate to make any definitive pronouncements in the absence of a more complete record focused on individual service offerings.

Several parties, including Senators Rockefeller, Snowe, Stevens, and Burns, urge that IP telephony providers offer interstate telecommunications services and, consequently, should contribute to universal service support mechanisms. Other parties, including Senator McCain, Representative White and the National Telecommunications and Information Administration, oppose application of Title II regulation. Some commenters argue that IP telephony is a nascent technology that is unlikely to generate significant revenues in the foreseeable future.

CLASSIFICATION OF SERVICES
As we have observed above in our general discussion of hybrid services, the classification of a service under the 1996 Act depends on the functional nature of the end-user offering. Applying this test to IP telephony, we consider whether any company offers a service that provides users with pure "telecommunications." We first note that "telecommunications" is defined as a form of "transmission." Companies that only provide software and hardware installed at customer premises do not fall within this category, because they do not transmit information. These providers are analogous to PBX vendors, in that they offer customer premises equipment (CPE) that enables end users to engage in telecommunications by purchasing local exchange and interexchange service from carriers. These CPE providers do not, however, transport any traffic themselves.

PC-To-PC
In the case of "computer-to-computer" IP telephony...The Internet service providers over whose networks the information passes may not even be aware that particular customers are using IP telephony software, because IP packets carrying voice communications are indistinguishable from other types of packets...Without regard to whether "telecommunications" is taking place in the transmission of computer-to-computer IP telephony, the Internet service provider does not appear to be "provid[ing]" telecommunications to its subscribers.

Phone-To-Phone
"Phone-to-phone" IP telephony services appear to present a different case. In using the term "phone-to-phone" IP telephony, we tentatively intend to refer to services in which the provider meets the following conditions: (1) it holds itself out as providing voice telephony or facsimile transmission service; (2) it does not require the customer to use CPE different from that CPE necessary to place an ordinary touch-tone call (or facsimile transmission) over the public switched telephone network; (3) it allows the customer to call telephone numbers assigned in accordance with the North American Numbering Plan, and associated international agreements; and (4) it transmits customer information without net change in form or content.

Specifically, when an IP telephony service provider deploys a gateway within the network to enable phone-to-phone service, it creates a virtual transmission path between points on the public switched telephone network over a packet-switched IP network. These providers typically purchase dial-up or dedicated circuits from carriers and use those circuits to originate or terminate Internet-based calls...The provider does not offer a capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making available information. Thus, the record currently before us suggests that this type of IP telephony lacks the characteristics that would render them information services within the meaning of the statute, and instead bear the characteristics of telecommunications services.

We do not believe, however, that it is appropriate to make any definitive pronouncements in the absence of a more complete record focused on individual service offerings. As stated above, we use in this analysis a tentative definition of "phone-to-phone" IP telephony. Because of the wide range of services that can be provided using packetized voice and innovative CPE, we will need, before making definitive pronouncements, to consider whether our tentative definition of phone-to-phone IP telephony accurately distinguishes between phone-to-phone and other forms of IP telephony, and is not likely to be quickly overcome by changes in technology. We defer a more definitive resolution of these issues pending the development of a more fully developed record because we recognize the need, when dealing with emerging services and technologies in environments as dynamic as today's Internet and telecommunications markets, to have as complete information and input as possible.

UPCOMING PROCEEDINGS
In upcoming proceedings with the more focused records, we undoubtedly will be addressing the regulatory status of various specific forms of IP telephony, including the regulatory requirements to which phone-to-phone providers may be subject if we were to conclude that they are "telecommunications carriers." We note that, to the extent we conclude that certain forms of phone-to-phone IP telephony are "telecommunications services," and to the extent the providers of those services obtain the same circuit-switched access as obtained by other interexchange carriers, and therefore impose the same burdens on the local exchange as do other interexchange carriers, we may find it reasonable that they pay similar access charges. On the other hand, we likely will face difficult and contested issues relating to the assessment of access charges on these providers. For example, it may be difficult for the LECs to determine whether particular phone-to-phone IP telephony calls are interstate, and thus subject to the federal access charge scheme, or intrastate. We intend to examine these issues more closely based on the more complete records developed in future proceedings.

With regard to universal service contributions, to the extent we conclude that certain forms of phone-to-phone IP telephony are interstate "telecommunications," and to the extent that providers of such services are offering those services directly to the public for a fee, those providers would be "telecommunications carriers." Accordingly, those providers would fall within section 254(d)'s mandatory requirement to contribute to universal service mechanisms. Finally, under section 10 of the Act, we have authority to forbear from imposing any rule or requirement of the Act on telecommunications carriers. We will need to consider carefully whether, pursuant to our authority under section 10 of the Act, to forbear from imposing any of the rules that would apply to phone-to-phone IP telephony providers as "telecommunications carriers."

We continue to believe that alternative calling mechanisms are an important pro-competitive force in the international services market. We [also] need to consider carefully the international regulatory requirements to which phone-to-phone providers would be subject. For example, it may not be appropriate to apply the international accounting rate regime to IP telephony.