Competition and Price Regulation in the Market for Public Long-Distance Telephone Services

Competition and Price Regulation

in the Market for Public Long-Distance

Telephone Services

Michael H. Ryan’

In 1992, the Canadian Radio-television and Telecommu-
nications Commission decided to permit competition in the pro-
vision of public long-distance telephone services. The advent of
competition has compelled the Commission to make sweeping
changes to the manner in which it regulates the prices charged by
the telephone companies and other telecommunications carriers
under its jurisdiction.

The article begins with a brief overview of the regulatory
regime as it stood prior to the introduction of competition. The
author describes the new measures the C.R.T.C. has introduced
to permit the incumbent telephone companies and their rivals in-
creased flexibility in the pricing of the services they provide to
the public.

The author then focuses on the Commission’s approach to
the special issues presented by the pricing of “access”. The tele-
phone companies own the local exchange and other access fa-
cilities to originate and terminate the calls carried over their long-
distance networks. In order to ensure equality of treamient be-
tween the telephone companies and their new competitors, the
Commission has instituted a form of accounting separation, un-
der which the long-distance arm of the telephone companies will
be forced to “purchase’ access services in a manner similar to
other long-distance carriers. This device will eliminate some of
the current asymmetries in the treatment of telephone companies
and their competitors in respect of access. At the same time, the
Commission has moved to correct many of the problems that
have undermined the confidence of competitors in the cost allo-
cation scheme, called Phase III, which has been used to set ac-
cess prices.

Finally, the author turns to the Commission’s new policy
on predatory pricing. He concludes that reliance on a pure in-
cremental cost standard would be inappropriate because the tele-
phone companies provide access and long-distance services on
an integrated basis and because of the numerous barriers to the
achievement ofa workably competitive market which persist.

le domaine des services

En 1992, le Conseil de Ia radiodiffusion et des tdecom-
munications canadiennes a d6cid6 de permettre Ia concurrence
dans
interurbains.
L’avnement de cette concurrence a contraint le Conseil A effec-
tuer des modifications radicales dans sa fagon de r6glementer les
tarifs exigda par les compagnies de tdl~phone et par d’autres
transporters en teldcommunications sous sajuridiction.

t~l~phoniques

L’article dbute avec un bref survol du rigime rnglemen-
taise en place avant l’introduction de la concurrence. L’auteur
dderit les nouvelles mesures introduites par le C.RIT.C. afin de
permettre aux compagnies de t~lphones ainsi qu’A leurs rivales
d’augmenter ler flexibilit6 dans la tarification des services
qu’elles offrent au public.

L’auteur se penche ensuite sur ‘approche du Conseil rela-
tivement aux questions particulitres prd6ents par In tarification
de 1’eacc” s. Les compagnies de te96phone d~iennent l’6change
local ainsi que les autres services d’accs pour commencer et
terminer les communications transport6s par leurs nrseaux in-
terurbains. Afin d’assurer l’igalit6 de traitement entre les compa-
gnies de tl6phone et leurs nouveaux concurrents, le Conseil a
institud une forme de sdparation de comptabilit6 selon laquelle
les dpartements des appels interurbains des compagnies de e06-
phone sont forcEs d’,cacheter* les services d’accs d’une manihre
semblable aux autres trmspotneurs d’intensrbains. Ce mdcanisme
permettwa d’dliminaer certaines asym~tries dans le traitement des
compagnies de tEl~phone et de leurs concurrents relativement A
I’acc s. De m8me, le Consel a agi afin de corriger plusiers
problames qui nt min6 la confiance des concurrents dans le
schUrne d’aliocation des coilts, aussi appelE la Phase Ill, utiliS
afin de d~terminer la tarification de I’accs.

Finalement, rauteur analyse la nouvelle politique du Con-
sell concemant le predatory pricing et conclut que se fier S une
norme de tarif purement marginale serait inapproprie Etant don-
nE que les compagnies de tElphone offient un acc s et des servi-
ces d’interurbain de mani re intdgre, et que plusieurs obstacles A
I’accomplissement d’un marchE compdtitif persisteront.

“Coudert Brothers, Solicitors, London, England. The author was formerly Vice-President, Law and
General Counsel of Unitel Communications Inc., Toronto, and acted for that company in several of
the proceedings mentioned in this article. The author acknowledges, with thanks, helpful comments
received from David Watt and Gary Pizante.

McGill Law Journal 1995
Revue de droit de McGill
To be cited as: (1995) 41 McGill LJ. 169
Mode de rf6rence : (1995) 41 R.D. McGill 169

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[Vol. 41

Synopsis

Introduction

I. The Regulatory Framework, Old and New

H. The Pricing of Access

IM. Predatory Pricing

A. The Northeastern Case
B. The MCI Case
C. The FC.C.’s Approach
D. The C.R.T.C.’s Approach

Conclusion

1995]

M.H. RYAN – COMPETITION AND PRICE REGULATION

Introduction

Prior to 1992, the provision of public long-distance telephone services in Can-
ada was largely the preserve of Bell Canada and the eight other major telephone
companies with which it is allied through the organisation called Stentor.’ Each of
the Stentor members provided service in its respective operating territory on a mo-
nopoly basis and collaborated with the other members to provide nation-wide
service. In 1992, however, in a decision entitled Competition in the Provision of
Public Long Distance Voice Telephone Services and Related Resale and Sharing Is-
sues,2
the Canadian Radio-television and Telecommunications Commission
(“C.R.T.C.” or “Commission”),
the authority which regulates the members of
Stentor’ and other Canadian telecommunications carriers, approved an application
by Unitel Communications Inc. (“Unitel”) to provide a public long-distance tele-
phone service to compete with the service provided by the Stentor members. The
C.R.T.C. simultaneously declared its readiness to permit further new entry by other
long-distance carriers , referred to in the industry as “interexchange carriers”
(“I.X.C.s”).’ Several have since emerged. As of December 31, 1994, competitors,
including so-called “resellers”‘, reportedly accounted for twelve percent of the
market for Canadian public long-distance telephone traffic. The single largest com-
petitor, Unitel, had a four and one-half percent market share.6

The advent of competition in the provision of Canadian public long-distance
telephone services has compelled the C.R.T.C. to reconsider the methods it has
traditionally followed in regulating prices charged by the Stentor members and to
devise new rules that are better tailored to the new competitive environment. In a

‘ The eight other telephone companies that are members of Stentor are: AGT Limited, BC TEL,
The Island Telephone Company Limited, Manitoba Telephone System, Maritime Tel & Tel Limited,
The New Brunswick Telephone Company Limited (“N.B. Tel.”), Newfoundland Telephone Company
Limited and Saskatchewan Telecommunications (“SaskTer’).
2(1992), Telecom. Decision C.R.T.C. 92-12 [hereinafter Long Distance Competition].
‘The C.R.T.C. does not regulate SaskTel. The Telecommunications Act, S.C. 1993, c. 38, s. 133,
provides that SaskTel shall not come under the jurisdiction of the C.R.T.C. until a date to be fixed for
that purpose by the Governor in Council on or after October 25, 1998 (the fifth anniversary of the
coming into force of the Act), unless the Government of Saskatchewan requests that an earlier date be
fixed.
‘ An I.X.C. is a telecommunications carrier that provides long-distance services between local tele-
phone exchanges but which does not itself own local exchanges. The term “telephone company” is
typically reserved in industry usage for those carriers, such as the members of Stentor, that own local
exchanges and provide both intra- and interexchange services. Interexchange (“.X.”) services include
not only public long-distance telephone service and enhancements, such as 800 service, but private-
line and data services, also. It is the former that has the most relevance to the discussion in this article.
‘ Resellers are companies which do not own their own transmission facilities and instead lease ca-
pacity from telephone companies and I.X.C.s. Resellers have been allowed to provide public long-
distance telephone service since 1990.

‘See letter of G. Pizante to the author (24 February 1995)”

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[Vol. 41

series of decisions that culminated in Review of Regulatory Framework,” released in
September 1994, the C.R.T.C. has made sweeping changes to the regulatory re-
gime. Among these changes is the abandonment of the system of “rate base/rate of
return” regulation’ –
the foundation of telephone company regulation for several
decades –
for the telephone companies’ competitive services. This has been re-
placed with a new scheme which will allow greater play to market forces in setting
prices.

One of the criticisms levelled at the Unitel application in the Long Distance
Competition proceeding was that it did not offer true competition but only
“regulated competition” –
a reference to the on-going role the C.R.T.C. would
have in regulating carrier prices –
and the Unitel proposal would, therefore, not
deliver the benefits normally associated with competition. The concept of regulated
competition is an anathema to many economists –
a “worst of both worlds” ap-
proach. Alfred Kahn has said that:

[There [is] no rational halfway house between thorough regulation and free
competition … [Riegulation confronted with competition will have a systematic
tendency either to suppress it … or to orchestrate it and control the results it
produces. Why? Because competition is unpredictable and messy, and the
regulator prizes predictability and tidiness. Businesses move in and out of
competitive markets. They are constantly changing their product and service
offerings, schedules and prices. The regulator, in contrast, prefers continuity of
service and stability and uniformity of prices and service offerings.”

‘(1994), Telecom. Decision C.R.T.C. 94-19 [hereinafter Regulatory Framework].
‘Under rate base/rate of return regulation, the regulator establishes a rate base equal to the value of
the capital invested (or the total value of the plant employed) in the enterprise and fixes a rate of re-
turn on that base. Rates are then set in such a way that the revenues they generate, minus permissible
expenses, equal the allowed rate of return.

‘Bell Canada, for instance, which was one of the respondents to the Unitel application, argued that

the aberrant variants of competition [suggested by Unitel and its co-applicant in the
case, BCRail/Lightel Inc.], would result in serious industry inefficiencies, would be
detrimental to telecommunications users and would significantly increase the regula-
tory burden. Under regulated competition, competitors would not be subject to the dis-
cipline of competitive market forces and they could frequently gain more by focusing
their efforts on the regulatory forum rather than on the marketplace, looking to the
Commission to protect their inefficient operations. Consumers would not be well
served under this market structure which would, through the regulatory process, delay
the introduction of new services and innovations, retard price decreases and increase
the costs of service (Argument of Bell Canada on the Issues raised in CRTC Telecom.
Public Notice 1990-73, Technical Paper No. 11 (29 July 1991) at 1).

“A. Kahn, “The Uneasy Marriage of Regulation and Competition” (1984) 1 Telematics 1 at 8-9,
quoted in W.T. Stanbury, The Case for Competition in Public Long Distance Telephone Service in
Canada (Unitel, August 1990) at 47 [unpublished]. The Stanbury evidence was commissioned and
filed by Unitel.

1995]

M.H. RYAN – COMPETITION AND PRICE REGULATION

Still, as W. T. Stanbury noted in evidence filed in the Long Distance Competition
proceeding, “[w]hile the concept of regulated competition is anomalous and the
practice of regulated competition may be a temporary ‘black art’, it is an unavoid-
able step in getting from here to there.”” This article proposes to examine the
Commission’s approach to price regulation in the newly-competitive market for
public long-distance telephone services and the progress of the industry on the road
from “here to there”.

The analysis will proceed as follows: Part I provides a brief description of the
regulatory regime as it stood prior to the Regulatory Framework decision and then
details the new measures aimed at providing the telephone companies with in-
creased pricing flexibility. This lays the groundwork for the discussion in Part II
and Part Ell.

Part II is concerned with the Commission’s approach to the pricing of the tele-
phone companies’ local exchange, or “access”, facilities. The pricing of access has
been rightly described as one of the most vexing issues facing telecommunications
regulators.” Access facilities consist of the network of wires running between the
local switch and customers’ premises which are used by both the telephone com-
panies and I.X.C.s to originate and terminate calls carried over their long-distance
(“interexchange”, or “I.X.”) facilities.” The fact that ownership of these facilities is
in the hands of the telephone companies creates the danger that they will charge
competitors more for access than the cost that they themselves incur in providing
their own services, thereby inflating competitors’ cost structures and undermining
their ability to price compete.

In 1985, the Commission introduced a cost-allocation scheme (called “Phase
II”) which was intended to combat this problem by identifying the relevant access
costs.” The costing of telecommunications services is an extraordinarily complex
matter, however, due in no small part to the large proportion of costs associated
with the provision of facilities used in common by different services. There has
been continual controversy over the accuracy and reliability of Phase III alloca-
tions, which competitors have claimed results in access charges being overstated by
at least thirty-five percent.”

” Stanbury, ibid. For a discussion of issues related to the regulation of competition in the Canadian
telecommunications sector, see H.N. Janisch, “From Monopoly Towards Competition in Telecom-
munications: What Role for Competition Law?” (1994) 23 Can. Bus. L.J. 239.
‘2See W.J. Baumol & J.G. Sidak, “The Pricing of Inputs Sold to Competitors” (1994) 11 Yale J. on
Reg. 171 at 172.
3 See supra note 4 for an explanation of this terminology.
14 See Inquiry into Telecommunications Carriers’ Costing and Accounting Procedures: Phase III-
Costing of Existing Services (1985), Telecom. Decision C.R.T.C. 85-10 [hereinafter Phase III Deci-
sion]. The impetus for the development of Phase III came from the Commission’s decision a few
years earlier to allow competition in the provision of private line voice and data services and terminal
equipment.

“See Unitel, Final Argument (17 January 1994), filed in Regulatory Framework, at c. 4 [hereinafter

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[Vol. 41

In the Regulatory Framework decision, the Commission attempted to escape
the difficulties associated with costing by adopting a new scheme under which the
telephone companies’ rate base will be split into a “utility” segment, comprised of
access and monopoly services, and a “competitive” segment. Under this scheme,
the telephone companies’ competitive services will be required to “purchase” ac-
cess services from the utility segment at tariffed rates in the same manner as
I.X.C.s. The net effect will be to increase the transparency of intra-telephone com-
pany dealings and to eliminate some of the asymmetries that currently exist in the
way telephone companies and I.X.C.s are treated in respect of access charges. The
new regime, however, inherits a vital weakness from the old: because the splitting
of the telephone companies’ rate bases will be accomplished using Phase Ill alloca-
tions, the existing problems with Phase III will be perpetuated rather than elimi-
nated unless corrective action is taken. These matters are discussed more fully in
Part Il.

Part III focuses on a different subject. A key component of the new framework
is a set of rules designed to check any attempt by the telephone companies to abuse
their new pricing flexibility by pricing predatorily. Predation has been defined as
“the deliberate sacrifice of.present revenues for the purpose of driving rivals out of
the market and then recouping the losses through higher profits earned in the ab-
sence of competition.”‘” The risk of predatory behaviour is enhanced considerably
in the situation of firms, like the Stentor telephone companies, which operate simul-
taneously in monopoly and competitive markets because of the potential which ex-
ists for such companies to use their monopoly services to fund price cuts in their
competitive markets. As we shall see, the cost standard adopted by the Commission
differs from that used, for instance, by the Director of Investigation and Research
under the Competition Act’ and is intended to recognize the particular characteris-
tics of an industry that is still in a stage of transition from monopoly to competition.
In Part III, the Commission’s approach is compared with the cost standards used by
the Director of Investigation and Research, the American civil courts in antitrust
cases and the C.R.T.C.’s counterpart in the United States, the Federal Communica-
tions Commission (“F.C.C.”).

I. The Regulatory Framework, Old and New

The mandate under which the C.R.T.C. operates requires it to ensure that the
rates telephone companies charge for their services are “just and reasonable”, and
that they do not unjustly discriminate between customers or customer groups, or
confer an undue preference on any particular customer or customer group in rela-

Unitel Final Argument].

“P. Areeda & D.F. Turner, Antitrust Law: An Analysis ofAntitrust Principles and their Application,

vol. 3, 3d ed. (Toronto: Little, Brown, 1978) at 151.

7R.S.C. 1985, c. C-34.

19951

M.H. RYAN – COMPETITIONAND PRICE REGULATION

tion to the provision of services and facilities.”8 Compliance with these requirements
has traditionally been enforced by requiring the telephone companies to file tariffs
setting forth the terms and conditions on which their services and facilities are
supplied and subjecting all changes in those tariffs to the prior approval of the
C.R.T.C.

Over the years during which the telephone companies had a monopoly on the
provision of public long-distance telephone services, the C.R.T.C. and its predeces-
sors developed a complex, and often arcane, set of policies, rules and regulations
designed to give substance to the legislative imperatives of justness, reasonableness
and non-discrimination. Under this regime, telephone companies were subject to a
particularly stringent form of rate regulation characterized by the following fea-
tures: the establishment of an overall limit on the permitted return on the carrier’s
total capital investment (to prevent the earning of unreasonably high profits); a
price structure that embodied an elaborate system of cross-subsidies flowing from
long-distance to local services, urban to rural customers and central Canada to other
regions of the country (principally in aid of the key policy objective of maintaining
universal access to basic telephone services at affordable rates); and a cost-
allocation scheme designed, inter alia, to detect any improper cross-subsidization
by monopoly services of those limited services which, prior to the Long Distance
Competition decision, were offered on a competitive basis (to ensure that monopoly
subscribers did not bear the risk of such endeavours, and that telephone company
competitors were not unfairly disadvantaged).

To the extent that competition in the provision of services was allowed at all, 2 it
took place under strictly regulated conditions. In 1983, the C.R.T.C. prescribed that
prices charged by CNCP Telecommunications, a provider of interconnected private-
line services, could not be more than five percent below those of the telephone
companies in the case of bulk facilities and no more than ten percent below in the
case of I.X. voice-grade facilities’.2 When the C.R.T.C. decided in 1987 to “detariff”

‘8 Telecommunications Act, supra note 3 at ss. 25, 27.
‘+ These arrangements are described in more detail in M.H. Ryan, Canadian Telecommunications

Law and Regulation (Scarborough: Carswell, 1993) at 6-32 to 6-52.

20 CNCP Telecommunications, the precursor of Unitel, had been authorized to interconnect its pri-
vate line voice and data services to the telephone company network in 1979 (see CNCP Telecommu-
nications: Interconnection with Bell Canada (1979), Telecom. Decision C.R.T.C. 79-11). See also
CNCP Telecommunications: Interconnection with the British Columbia Telephone Company (1981),.
Telecom. Decision C.R.T.C. 81-24. Interconnection was permitted subject to the express stipulation
that the connections furnished not be used for the provision of public long-distance telephone service.
21 See CNCP Telecommunications – Rates for the Provision of Interconnected Private Line Voice
Service (1983), Telecom. Decision C.R.T.C. 83-10, application to review and vary den’d Bell Canada
and British Columbia Telephone Company – Applications to Review Telecom. Decision CRTC 83-10
(1984), Telecom. Decision C.R.T.C. 84-19. Indeed, the C.R.T.C. initially refused to permit any differ-
ential at all and was only persuaded to allow the five and ten percent differentials on the ground that
they were necessary to compensate for the market perception that the CNCP services were inferior in
quality to the corresponding telephone company services (see CNCP Telecommunications – Special

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[Vol. 41

CNCP’s services – a decision later overturned on jurisdictional grounds’ –
it ex-
pressly retained price regulation for private-line voice services, “because of the ne-
cessity of ensuring that appropriate rate relationships are maintained with directly
competing services provided by the telephone companies and with [public long-
distance telephone service].”‘

The Commission’s private-line pricing decisions may furnish a particularly
vivid illustration of the regulatory obsession with predictability and tidiness (see
Kahn, above). They were motivated, however, by a fundamental concern about the
potentially de-stabilizing effect competition from private-line services might have
on the existing system of cross-subsidies and, therefore, on local rates. The con-
tinuance of those subsidies depended on the maintenance of high prices for I.X.
services which would not be sustainable if private-line rates were allowed to fall.
This same concern about maintenance of low local rates led the Commission to
deny an application by CNCP to provide a competing public long-distance tele-
phone service in 1985.’

While endorsing the concept of new entry, the Long Distance Competition de-
cision revealed a continuing ambivalence on the part of the Commission to the
prospect of price competition for switched voice services. It agreed to “streamline”
the tariff approval process governing Stentor’s competitive services by allowing the
filing of tariffs on an ex parte basis in certain circumstances,’ thereby dispensing
with the process of public comment that sometimes led to delays in the implemen-
tation of Stentor price initiatives. The C.R.T.C. also affirmed that “optional”2 toll
services would no longer be subject to the policy that rates should “maximize con-

Tariffs Covering the Provision of Interconnected Private Line Voice Service (1982), Telecom. Deci-
sion C.R.T.C. 82-9). For related decisions, see: CNCP Telecommunications – MACH 111 Service and
Related Matters (1988), Telecom. Decision C.R.T.C. 88-17; British Columbia Telephone Co. v. B.C.
Rail Telecommunications – Rates for Interconnected Interexchange Voice Grade Services (1991),
Telecom. Decision C.R.T.C. 91-17.

22CNCP Telecommunications- Application for Exemption from Certain Regulatory Requirements
(1987), Telecom. Decision C.R.T.C. 87-12 [hereinafter Application for Exemption], rev’d (sub nom.
TWU. v. CRTC) (1988), [1989] 2 F.C. 280,98 N.R. 93 (C.A.).
‘Applicationfor Exemption, ibicL at 16-17.
2, See Interexchange Competition and Related Issues (1985), Telecom. Decision C.R.T.C. 85-19.
For a particularly vigorous critique of this decision, see W.T. Stanbury, “Decision Making in Tele-
communications: The Interplay of Distributional and Efficiency Considerations” in W.T. Stanbury,
ed., Telecommunications Policy and Regulation: The Impact of Competition and Technological
Change (Montreal: Institute for Research on Public Policy, 1986) at 481.

While the concern about local rates was ultimately overcome in the Long Distance Competition
the Commission pronounced itself satisfied that the terms of entry it fixed obviated the
local rates

decision –
need for any local-rate increase (see Long Distance Competition, supra note 2 at 13) –
continue to be a preoccupation of public policy (see e.g. text accompanying note 45ff, below).

“Long Distance Competition, ibid at 139-40.
2 An optional long-distance telephone service is a conventional (or “basic”) long-distance telephone
service offered under an alternative pricing plan; for example, by payment of a flat subscription fee
for a specified number of hours of “free” calling.

1995]

M.H. RYAN – COMPETITION AND PRICE REGULATION

tribution”.” However, the Commission otherwise declined to take any measures to
liberalize the rules governing Stentor member pricing.’

The telephone companies responded to the Long Distance Competition decision
by launching a campaign for a move towards what Bell Canada’s then C.E.O.,
Robert Kearney, termed “more natural markets” for telecommunications services.’
Stentor filed a Petition with the Governor in Council seeking a modification of the
Long Distance Competition decision? In that document, Stentor claimed that “[t]he
Commission [had] opted for wide open competition but without relieving the tele-
phone companies from a regulatory structure which increases their costs and im-
pedes their progress.” Stentor asked for a relaxation of what it described as a
“heavy-handed” regulatory process, so that its members would have “the flexibility
to act quickly in the market”.’

It seems probable that the Commission would have moved in the direction of
regulatory reform of its own accord, but the Petition provided an impetus for doing
so immediately. Within months of the Long Distance Competition decision, the
Commission initiated the proceeding which led to the Regulatory Framework deci-
sion.” The Commission said that it intended to examine whether “the current regu-
latory framework is the most appropriate or effective [means] to serve the public
interest” and invited submissions concerning, among other matters, the ways in
which regulation might be streamlined or regulatory requirements eliminated “in
light of changes in industry structure”.” Parties were also asked to address what
“regulatory safeguards may be necessary to protect against abuse of dominant
power in competitive markets.”‘

27Long Distance Competition, supra note 2 at 139. The policy of contribution maximization re-
quires that rates for long-distance services be kept at high levels to generate the maximum contribu-
tion to the maintenance of the cross-subsidy to local service.
8The Commission said that it found it “appropriate that, in general, the present regulatory frame-
work continue to apply” to the Stentor members, including rate of return regulation and the require-
ment to provide supporting information for proposed tariff revisions (Long Distance Competition,
ibid.). I.X.C.s were at the same time freed of the obligation to cost justify their rates. With this re-
quirement removed, I.X.C.s are now able to change their rates, largely at will, although the require-
ment to file tariffs remains in place (ibid. at 141).

29L. Surtees, “Bell Canada’s new chief wants to end regulation” The [Toronto] Globe and Mail (8

March 1993) B4.

” Petition to the Governor in Council pursuant to section 67 of the National Telecommunications
Powers and Procedures Act delivered by Stentor Telecom Policy Inc. (5 August 1992) [hereinafter
Petition].

3 Petition, ibid. at 1-5.
32 ith the announcement of the new proceeding, the Stentor Petition was withdrawn (see Stentor,
News Release, “Regulatory Reform Initiatives Prompt Stentor to Withdraw Petition to Cabinef’ (26
January 1993)).

“Review of Regulatory Framework (1992), Telecom. Public Notice C.R.T.C. 92-78 at 2.
4 ibid at4.

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[Vol. 41

In the Regulatory Framework proceeding, the Commission recognized that the
inflexibility of its traditional method of rate regulation would hinder the achieve-
ment of the benefits of competition, such as increased efficiency and more rapid in-
novation, which had motivated the Long Distance Competition decision. It con-
cluded that some liberalizing of the telephone-company pricing regime was neces-
sary to ensure that these companies had the incentive and the ability to act com-
petitively. The Commission announced four new measures aimed at increasing the
pricing flexibility available to the telephone companies:

(1) Removal of the constraint on price increases for optional long-distance
telephone services and 800 services. The C.R.T.C. expressed the view that
competition will provide sufficient protection against significant price rises
for these services and, therefore, decided that there should be no regulatory
controls over price increases.”

(2) Relaxation of the rules governing prices for basic (that is, other than op-
tional) long-distance telephone services to points within North America.
The Commission indicated that it will give expedited approval to rate re-
visions that do not result in an overall price increase for these services; that
is, increases in, for example, peak-period prices must be offset by de-
creases in off-peak period prices so that the change will be “revenue neu-
tral”. Proposed departures from that requirement (as well as rates for over-
seas services) will continue to be examined on a case-by-case basis.

(3) Relaxation of the rules relating to non-discrimination to enable carriers to
introduce “customer-specific” arrangements. According to the Commis-
sion, this change will allow telephone companies greater flexibility in
packaging and pricing their services. Any such arrangement will remain,
however, subject to a variety of conditions, including a test designed to
prevent cross-subsidization. “Service packages”
introduced under this
measure must be made available to other customers on similar terms.

(4) Imposition of a “price cap” on utility services. Instead of regulating the
price of individual services, price caps regulate the rate of change in the
price of a “basket” of services. The permitted rate of change is typically
fixed in relation to the annual rate of increase in the consumer-price index
or some similar index of prices in the economy. So long as the aggregate
change of prices for services in the basket observes the cap, approval of
individual price changes is not required. The form the new price-cap re-
gime will take is deferred to a separate proceeding to be initiated in the
first half of 1996, with a view to implementation on January 1, 1998.

” For a description of the regime governing price decreases, see Part III, below.

1995]

M.H. RYAN – COMPETITION AND PRICE REGULATION

In certain market segments, the Commission has since gone further. In a series
of decisions which reflects the liberalizing philosophy of the Regulatory Frame-
work decision, the Commission has decided to forbear from rate regulation of
wireless services,’ the sale, lease and maintenance of terminal equipment and the
sale and lease of earth stations.”

On September 8, 1995 the Commission took another important step toward lib-
eralizing telecommunications markets by deciding to forbear entirely from rate
regulation of I.X.C.s. 9

IH. The Pricing of Access

Access service is one area in which competition has yet to establish itself and
where the traditional rationale for rate regulation –
to prevent the charging of ex-
cessively high rates and to prevent undue discrimination between customers –
continues to apply.’ Because access is an input to other services that are themselves
furnished on a competitive basis, however, there is an additional rationale for regu-
latory intervention, namely, to ensure equality of treatment between telephone
companies and their competitors. It is worth drawing attention to this point, in view
of the criticisms of “regulated competition”,” because it underscores the fact that
regulation is, in this respect at least, not merely a relic of the former monopoly in-
dustry structure but is a product of the move toward competition.

Because of the way telephone tariffs are structured, customers do not pay any
express charges for the use of access facilities. Instead, telephone companies re-
cover their access costs through the charges their customers pay for local, I.X. and
other services. The revenues the telephone companies earn in providing these serv-
ices are, in each case, sufficient to cover the direct costs of those services plus a
surplus. The surplus revenues generated by each service constitute that service’s
“contribution” to the recovery of total access costs. Historically, tariffs have been
designed so that I.X. services make a far larger contribution than local services to
access costs. It is in this sense that I.X. services are sometimes said to “subsidize”
local services.

6See Regulation of Wireless Services (1994), Telecom. Decision C.R.T.C. 94-15.
” See Forbearance –

Sale of Terminal Equipment by Canadian Carriers (1994), Telecom. Deci-

sion C.R.T.C. 94-14 at 76ff.

“8 See Telesat Canada- Forbearance for the Sale and Lease of Earth Stations (1994), Telecom.

Decision C.R.T.C. 94-23.

‘9 Forbearance –
Services Provided by Non-Dominant Canadian Carriers (1995), Telecom. De-
cision C.R.T.C. 95-19.
40 It appears that access services, too, may ultimately become available from competitive sources of
supply. The Commission expressed the view in the Regulatory Framework decision, that “the poten-
tial exists for meaningful local competition in basic telecommunications and in many of the informa-
tion-based telecommunications markets” and its intention to encourage that potential (Regulatory
Framework, supra note 7 at 33).

” See supra notes 9-11 and accompanying text.

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[Vol. 41

In the Long Distance Competition decision, the C.R.T.C. determined that
I.X.C.s utilizing telephone-company access facilities should make a contribution to
the subsidy that matched the contribution generated by comparable telephone-
company services.” There was a significant difference in the manner in which that
contribution was calculated and collected from the telephone companies and
I.X.C.s under this regime. Because the telephone companies provide I.X. and ac-
cess services through the same corporate entity, their I.X. services’ contribution to
access was notional only; it could be calculated as the difference between I.X.
revenues and costs on an ex post facto basis for a given accounting period but in-
volved no actual payments. By way of contrast, the contribution paid by competi-
tors takes the form of explicit payments.

The asymmetry inherent in this scheme of explicit charges for competitors and
implicit charges for telephone companies provoked concerns on the part of com-
petitors about the potential for unequal treatment. These concerns centred on the
Phase III allocations. Under Phase I, telephone-company costs are allocated to a
number of broad service categories, including “access” and two separate I.X. serv-
ice categories, namely, “competitive toll” for switched voice services and
“competitive network” for private-line voice and data services. It was alleged that
the telephone companies had been mis-allocating costs to access that should have
been allocated to one of the I.X. service categories, thereby overstating the contri-
bution made by their own services and, by extension, the matching contribution due
from competitors. These concerns were exacerbated because contribution payments
represent a substantial percentage of I.X.C. revenue and a miscalculation could,
therefore, have a devastating financial impact on the industry.

This decision to split the telephone companies’ rate bases and impose a charge
on all dealings between the utility side of the telephone companies’ operations and
I.X. service providers, including the I.X. side of the telephone company,” assures
that, in future, there will be a formal symmetry” in the contribution arrangements as

,2 Provision was made for a “contribution discount” during a transitional period which was designed
to offset the advantages accruing to the telephone companies as a result of their control of local ex-
changes and their historically dominant positions (Long Distance Competition, supra note 2 at 84).

“‘ Economists will see in the C.R.T.C.’s approach key elements of the efficient-component pricing
rule articulated in Baumol & Sidak, supra note 12, and discussed in: A.E. Kahn & W.E. Taylor, “The
Pricing of Inputs Sold to Competitors: A Comment” (1994) 11 Yale J. on Reg. 225; W.B. TIye, “The
Pricing of Inputs Sold to Competitors: A Response” (1994) 11 Yale J. on Reg. 203. For a discussion
of the application of the efficient-component pricing rule in the context of a suit alleging abuse of
dominant position arising out of a disagreement over terms and conditions of interconnection, see
Telecom Corporation of New Zealand v. Clear Communications Ltd., [1995] 1 N.Z.L.R. 385 (P.C.).

“The rules governing contribution that are now in place are not completely symmetrical. In the
Regulatory Framework decision, the Commission determined that the access charge payable by both
the telephone companies and I.X.C.s should take the form of a per-minute charge (supra note 7). The
Commission has since decided to revert, however, for the time being, to the levy per interconnecting
trunk originally adopted for I.X.C. traffic in the Long Distance Competition decision (see Applica-
tions by Unitel Communications Inc. and Sprint Canada Inc. to Review and Vary Part of Decision 94.

1995]

M.H. RYAN – COMPETITION AND PRICE REGULATION

they apply to telephone companies and competitors. This decision does nothing,
however, in and of itself, to resolve concerns about the substantive problem of
costing. This is because the division of the telephone companies’ rate bases is to be
effected by splitting these rate bases according to existing Phase III allocations. If,
indeed, Phase m harbours significant cost misallocations that inflate access costs,
these will inevitably be perpetuated in inflated contribution charges.

Not only competitors would be harmed in such a case. Rates for local service are
also set with reference to total access costs. As part of the Regulatory Framework de-
cision, the Commission announced that monthly local rates would be raised by six
dollars in equal stages of two dollars in each of the next three years.’ This decision was
premised on the belief that there is a large revenue/cost imbalance in the access cate-
gory, and that local service is therefore not making a sufficient contribution to the re-
covery of the revenue shortfall. If Phase IlI, in fact, overstates access costs, this local
rate increase may not be warranted.

Unitel believed it found confirmation of its concerns about cost misallocations in a
“benchmarking” exercise in which it compared the cost per minute of providing I.X.
service reported by major long distance carriers in the United States – A.T.&T., MCI
and Sprint –
and Bell Canada’s cost per minute calculated using Phase III allocation
procedures. These comparisons suggested that the costs of the carriers in the United
States were about double those of Bell Canada. Since the U.S. carriers all provide long-
distance service on a stand-alone basis (that is, they do not provide access or local
services), their cost data is not complicated by allocation issues. Unitel, supported by
other I.X.C.s and consumer groups, argued that it was implausible that carriers in the
United States could have I.X. costs that are so dramatically higher than Bell Canada’s
and alleged that Phase III was mis-allocating costs of providing I.X. services to the ac-
cess category.

These allegations persuaded the Commission to appoint one of its members to
conduct an inquiry into Phase III. As a result of the Inquiry, some significant modifica-
tions were made to Phase I’
(the contribution rates payable by competitors fell by
approximately ten percent), but these changes failed to address all of the concerns of
the critics of Phase Ill. An alliance of industry competitors and other interested partici-
pants, grouped together in the Competitive Telecommunications Alliance, subse-
quently filed a Petition with the Governor in Council under the provisions of the Tele-
communications Act asking the Governor in Council to institute an independent inquiry

19 (1994), Telecom. Decision C.R.T.C. 94-27, announcing the change and explaining the reason for
the decision to levy access charges on I.X.C. traffic on a per-trunk basis instead of the per-minute ba-
sis applied to telephone company traffic). See also De-Averaged Per-Minute Contribution Mechanism
(1994), Telecom. Public Notice C.R.T.C. 94-59.

4
1 See Regulatory Framework, ibid.
1 See Review of Phase III: Report of the Inquiry Officer (1994), C.R.T.C. Telecom. Decisions, Let-
ter Decisions and Public Notices, vol. 2, number 29. The recommendations contained in the Report
were adopted by the Commission in Review of Phase III of the Cost Inquiry (1994), Telecom. Deci-
sion C.R.T.C. 94-24.

4

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[Vol. 41

into the subject of cost allocations. In response to that Petition and a parallel Petition by
consumer groups expressing concern about the local-rate increases proposed by the
C.R.T.C. in the Regulatory Framework decision, the Governor in Council directed the
C.R.T.C. to reconsider the proposed local-rate increases. It also indicated its view that it
was material to the reconsideration that the Commission compare Phase I cost allo-
cations to “external benchmarks”.

The Commission accordingly joined these issues to a new proceeding concerning
implementation of the Regulatory Framework decision. During the course of that pro-
ceeding, it became clear that some of the discrepancies that Unitel believed it had
found between the I.X. costs reported by carriers in the United States and Bell Can-
ada’s Phase III results were traceable to economies of scope that Bell Canada enjoyed
because it provides access, local and I.X. services on an integrated basis. This integra-
tion allows Bell Canada to share costs for certain functions that are jointly used by all
services (customer service; network planning, installation, operation and maintenance;
computer and information systems; and general overhead and administration) across
the whole range of its telecommunications services, while the United States I.X. carri-
ers are, perforce, required to allocate all of those costs to their I.X. services alone. In
implementing Phase III, it became clear that Bell Canada (and the other Canadian tele-
phone companies) had chosen to distribute these joint costs among their services in a
manner that maximized the costs allocated to access and minimized those allocated to
LX. services.

I.X.C.s argued that, if competition is to take place on a fair basis, the telephone
companies’ Phase II allocations ought to resemble as closely as possible the costs in-
curred by stand-alone providers of I.X. services, and that joint costs should, therefore,
be distributed so as to achieve this result. The Stentor telephone companies strenuously
argued against this approach. They claimed that such proposals would effectively re-
quire them to share the cost advantages they derived from their integrated structure
with competitors, and that this was both unjust and economically inefficient.

The Commission released its decision in this proceeding on October 31, 1995.”‘
Although the Commission rejected the results of Unitel’s benchmarking comparison, it
accepted that certain (but not all) of the joint costs referred to by Unitel ought to be al-
located differently. Specifically, the Commission directed that customer service costs
should be allocated under the new split-rate base to the utility segment and the com-
petitive segment equally. This will reduce contribution rates significantly. No explana-
tion was provided as to why other joint costs should not be treated similarly. The
Commission also decided to modify its plans for local rate increases. Local rates will
increase by two dollars per month in each of the next two years, as originally contem-
plated by the Regulatory Framework decision, but a decision about the magnitude of
the third increase will be deferred until a future date.

47P C. 1994-2036 (13 December 1994) at 2.
48 See Implementation of Regulatory Framework- Splitting of the Rate Base and Related Issues
(1995), Telecom. Decision C.R.T.C. 95-21 [hereinafter Split Rate Base].

1995]

M.H. RYAN – COMPETITION AND PRICE REGULATION

At the present time, it is unclear what the reaction of I.X.C.s, telephone companies,

consumer groups and other interested parties will be to the decision.

M. Predatory Pricing

Pricing which is below “cost” will normally be regarded as prima facie
“predatory”.” The measure of cost which is employed for this purpose is, of course,
crucial since differing measures of cost can lead to radically different results. While
the subject of the appropriate cost standard to use in judging whether a rate is
predatory is one which has engendered a great deal of debate, it is now widely, but
by no means universally, accepted that some measure of variable cost (marginal
cost or average variable cost (“A.V.C.”), long-run incremental cost (“L.R.I.C.”) or
avoidable cost)’ is to be preferred to measures of total cost (average total costs or
fully-distributed costs (“F.D.C.”)).

The C.R.T.C. has crafted its own cost standard which differs materially from all
of these. Though the Commission implicitly accepts that variable costs form a
proper starting point for the analysis of predation, in order to ensure fairness to
competitors it has decided that contribution should also be imputed to telephone
company I.X. services, even though local-exchange costs are fixed in character.

” There are circumstances where a price below cost will not be regarded as predatory; for example,
where the vendor is merely minimizing losses in a market where there is excess capacity or is selling
off perishable inventory (see: Director of Investigation and Research, Predatory Pricing Enforcement
Guidelines (Ottawa: Supply & Services Canada, 1992) at 10 [hereinafter Predatory Pricing Enforce-
ment Guidelines]; R. v. Consumer’s Glass Co. (1981), 33 O.R. (2d) 228, 124 D.L.R. (3d) 274 (H.C.J.)
[hereinafter Consumer’s Glass]).

” The first of these, marginal cost (Le., the cost of supplying one additional unit of the service in
question) is usually accepted as the theoretical ideal, but since marginal cost cannot normally be de-
rived from a firm’s accounting records, a variety of proxies is used. The Director has indicated that a
price below A.V.C. is likely to be regarded as in violation of the Competition Act requirement that
prices not be “unreasonably low” (Competition Act, supra note 17 at s. 50(1)(c)). The Director has
defined A.V.C. as inclusive of all costs that vary with the level of output (see Predatory Pricing En-
forcement Guidelines, ibid. at 10-11). The A.V.C. standard was applied in Consumer’s Glass. The
Second and Seventh Circuit Courts of Appeal applied an L.R.I.C. standard in both Northeastern Tele-
phone Company v. A.T&T, 497 FSupp. 230 (D. Conn. 1980) [hereinafter Northeastern (Trial)], rev’d
651 E2d 76 (2d Cir. 1981) [hereinafter Northeastern] and MCI Communications Co. v. A.T&T, 708
F.2d 1081 (7th Cir. 1983) [hereinafter MCI]. L.R.I.C. was defined in the latter case as the average
additional cost of a large change in production of the service. Long-run avoidable cost, on the other
hand, was the standard preferred in G. Myers, Predatory Behaviour in UK Competition Policy: Re-
search Paper (London: Office of Fair Trading (U.K.), 1994). According to Myers, “long-run avoid-
able cost is closely related to ‘incremental cost’ … There is a difference between the two if there exist
costs that are sunk in the long run and do not require replacement -these
sunk costs are included in
the incremental costs but excluded from the long-run avoidable costs” (Myers, ibid. at note 1, p. 20).

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[Vol. 41

It is useful to an understanding of the C.R.T.C.’s approach to the issue of pre-
dation to preface our examination of it with a review of the two leading antitrust
cases from the United States” on the issue of predatory pricing in the telecommuni-
cations industry. As we shall see, in both cases, the courts ultimately ruled in favour
of an incremental cost standard. In each instance, however, the appellate court was
required to overrule the lower court, which favoured F.D.C. Moreover, in one of the
cases, there was a dissent in the appellate court that is germane to the cost-standard
issue.

A. The Northeastern Case

The first of the two United States cases is Northeastern Telephone Company v.
A.T&T ‘2 Northeastern was a small supplier of telephone terminal equipment, based
in Connecticut, which sold private-branch exchanges (“P.B.X.s”) and key tele-
phones in competition with A.T.&T. and its affiliate, Southern New England Tele-
phone Company (“S.N.E.T.”). Northeastern, believing that the prices being charged
by S.N.E.T. were predatorily low, commenced an action under the Sherman Act’
seeking damages, inter alia, caused by the alleged attempt of the two defendants to
monopolize the relevant markets. At trial, the jury returned a verdict for Northeast-
ern and awarded damages which when trebled, as provided for by the Act,
amounted to over sixteen and one-half million dollars. The defendants moved for
judgment notwithstanding the verdict on the ground, inter alia, that the evidence
put before the jury was legally insufficient to support that verdict.

Eginton D.J. set aside the verdict as it related to the pricing of key telephone
systems but affirmed it with respect to P.B.X.s. The evidence had shown that, in
setting its rates, S.N.E.T. took into account only the incremental costs attributable
to the provision of P.B.X.s and did not attribute any portion of its indirect or com-
mon costs to that product. The court noted that, in previous decisions, several
courts had accepted the proposition that if a price recovers the marginal or incre-
mental costs of a product or service, it is not predatory; the court declined, how-
ever, to adopt that standard “on the particular circumstances of this case”.
“Instead,” the court said, “defendant’s pricing conduct will be viewed against a
pricing floor of fully distributed cost.” The court went on to explain:

Fully distributed cost combines the marginal or incremental cost of supplying a
particular good or service with some portion of the unattributable costs (i.e.,
indirect costs). Such a standard is particularly appropriate for a firm like
[S.N.E.T.] which sits astride noncompetitive and competitive markets and has
the potential to “undermine competition by supporting artificially low prices in
the terminal-equipment market with revenues from intrastate monopoly
services.”

,See also Southern Pacific Communications Co. v. AT&T, 556 ESupp. 825 (D.C. 1983), aff’d 740

E2d 980 (D.C. Cir. 1984) [hereinafter Southern Pacific].

51 Supra note 50.
” 15 U.S.C. 2 (1976).

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M.H. RYAN – COMPETITION AND PRICE REGULATION

One of the indicia of predatory pricing posited by Areeda & Turner is
whether a firm has engaged in the “deliberate sacrifice of present revenues for
the purpose of driving rivals out of the market and then recouping the losses
through higher profits earned in the absence of competition.” Although such a
test may be appropriate for the normal industrial firm which is in a competitive
situation in all sectors of its business, it is not appropriate for an entity like
[S.N.E.T.] which can support artificially low prices in the terminal equipment
market with revenues from monopoly services. To permit [S.N.E.T.] to allocate
all or a disproportionate percentage of its unattributable costs to the noncom-
petitive sector of its business – which defendants urge this Court to do under
the guise of long-run incremental analysis … –
is to give defendants an im-
proper pricing advantage over Northeastern and other single market competi-
tors who must allocate all costs directly to their terminal equipment rates. A
fully distributed cost standard, on the other hand, would require that the rates
for [S.N.E.T.]’s competitive products and services reflect some portion of its
unattributable costs, thus substantially curtailing potential subsidization. Under
the particular circumstances of this case, a fully distributed cost pricing floor is
the proper standard against which to measure defendants’ pricing practices.-‘

The finding for Northeastern was reversed on appeal to the Second Circuit
Court of Appeal. 5 The appellate court began its analysis by expressing its agree-
ment with Areeda & Turner, whose article on predatory pricing had been cited by
Eginton D.J.,’ that the appropriate benchmark against which to judge whether a
price is predatory is, generally, marginal cost. “Were this a run of the mill case,” the
court went on to say, it would proceed to apply the average variable cost rule to
S.N.E.T.’s P.B.X.’s prices. “But as Northeastern rightly contends, this case is far
from typical.””7 One of the “significant factors” which distinguished that case from
the classic situation was the fact that the prices charged by S.N.E.T. were regulated
by the Connecticut Department of Public Utility Control (“D.P.U.C.”) 8

The court characterized the trial judge’s approach as “seriously flawed”. First, it
stated, the argument that a regulated utility can allocate all of its joint costs to the
monopoly aspects of its business and, thereby, give itself a permanent advantage
over its unregulated competitors “proves too much”. This advantage, the court said,
may be enjoyed by all diversified firms, whether regulated or unregulated. The
Court continued:

Second, this approach emphasizes the interests of single-market rivals over
those of consumers and the competitive process. Marginal cost pricing maxi-
mizes short run consumer welfare. Fully distributed cost pricing, in contrast,
requires some consumers to pay a higher price for the desired product, and
forces others to do without that product entirely, although they are willing to

Northeastern (Trial), supra note 50 at 240-41 [citations omitted].
35See Northeastern, supra note 50.
‘6 See P. Areeda & D. Turner, “Predatory Pricing and Related Practices Under Section 2 of the

Sherman Act” (1975) 88 Harv. L. Rev. 697 at 698.

57Northeastern, supra note 50 at 90.
5 Ibid at 88.

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[Vol. 41

pay the costs of its production. Moreover, a fully distributed cost rule would
have perverse consequences when the dominant firm’s rival was itself diversi-
fied. In that case, presumably, both firms would have to set their prices above
their fully distributed costs. So high a price floor might prevent the diversified
rival from ever entering the market, thereby curtailing competition rather than
promoting it.

Third, Northeastern’s argument in favour of the fully distributed cost test is
based on a misunderstanding of the economic notion of subsidization, North-
eastern seems to believe that whenever a product’s price fails to cover fully
distributed costs, the enterprise must subsidize that product’s revenues with
revenues earned elsewhere. But when the price of an item exceeds the costs di-
rectly attributable to its production, that is, when price exceeds marginal or av-
erage variable cost, no subsidy is necessary. On the contrary, any surplus can be
used to defray the firm’s non-allocable expenses.

Finally, Northeastern’s fear that [S.N.E.T.] will be able to allocate all of its
overhead to its monopoly services rests on the premise that the [D.P.U.C.] is
either asleep or incompetent A key step in the long and complex business of
rate regulation is the “cost allocation study,” in which the regulatory agency
distributes fixed costs against the revenues from the regulated and unregulated
aspects of the utility’s operations. If Northeastern believes that the [D.P.U.C.] is
unable to perform these studies, its recourse is to intervene before that body
and, if unsuccessful, to appeal to the state courts. If comity and federalism
mean anything in this context, they require that we not create an exception to
the general rule of marginal cost pricing on the basis of plaintiff’s bald asser-
tion that the [D.P.U.C.] cannot perform the duties delegated to it by the state. 9

B. The MCI Case

There are many parallels between the facts in Northeastern and those in MCI.
MCI, which competed with A.T.&T. in the provision of private-line services, had
brought suit against A.T.&T. under the Sherman Act alleging that it had attempted
to monopolize the market for I.X. services through, inter alia, predatory pricing.
The object of MCI’s complaint was a service called ‘”Telpak”. In response to MCI’s
entry into the telecommunications field, A.T.&T. had formulated a plan known as
the “Hi-Lo tariff” under which A.T.&T. “de-averaged” its Telpak service rates into
two principal rate categories. On high-density routes (the target of MCI’s activity),
rates were lowered; while on low-density routes, rates were increased. The trial
judge left to the jury the question of whether the appropriate cost standard for de-
termining whether predation was occurring was ED.C. or incremental costs. The

“9Ibid at 90 [citations omitted].
6 See supra note 50. See also Southern Pacific, supra note 51, a case brought by another A.T.&T.
competitor which proceeded parallel to the MCI suit. Southern Pacific alleged that A.T.&T.’s Telpak,
Hi-Lo and private line tariffs were predatory. The trial court found that A.T.&T. had priced these of-
ferings above both L.R.I.C. and ED.C. and dismissed the plaintiff’s claims. On appeal, the Court of
Appeals expressed “serious doubts” about the usefulness of FD.C. as a measure of cost for use in the
context of predatory pricing claims but held that it was unnecessary to decide what standard was ap-
propriate in view of the trial court’s findings of fact (Southern Pacific, ibid. at 1006).

1995]

M.H. RYAN – COMPETITION AND PRICE REGULATION

jury found that the Hi-Lo tariff was priced below F.D.C. and was, therefore, preda-
tory. MCI was awarded treble damages amounting to 1.8 billion dollars.”

The Seventh Circuit reversed this decision, holding not only that the choice of
the cost standard was a question of law to be decided by the trial judge, but that the
appropriate measure was L.R.I.C. The court characterized F.D.C. as not “an eco-
nomically relevant definition of average total cost” in the antitrust context, elaborat-
ing as follows:

First, [F.D.C.] is a quite arbitrary allocation of costs among different classes of
service … [which] cannot purport to identify those costs which are caused by a
product or service, and this is fundamental to economic cost determination.
[F.D.C.] also fails as an economically relevant measure of cost for antitrust
purposes because it relies on historical or embedded costs. For it is current and
anticipated cost, rather than historical cost that is relevant to business decisions
to enter markets and price products. The business manager makes a decision to
enter a new market by comparing anticipated additional revenues (at a particu-
lar price) with anticipated additional costs. If the expected revenues cover all
the costs caused by the new product, then a rational business manager has
sound business reasons to enter the new market. The historical costs associated
with the plant already in place are essentially irrelevant to this decision since
those costs are “sunk” and unavoidable and are unaffected by the new produc-
tion decision. This factor may be particularly significant in industries such as
telecommunications which depend heavily on technological innovation, and in
which a firm’s accounting, or sunk, costs may have little relation to current
pricing decisions.
In particular, [F.D.C.] fails as a relevant measure of cost in a competitive mar-
ket. [F.D.C.] is, at best, a rough indicator of an appropriate rate ceiling for
regulatory purposes and should not be used as a measure of the minimum price
permissible in a competitive market. The justifiable fear of monopoly, and the
basis of section 2 of the Sherman Act, is that a firm enjoying monopoly power
will not be constrained by market forces; it will raise prices and decrease out-
put in such a manner that its own profit will be maximized but that consumers
will be subject to higher prices and a less efficient allocation of resources than
would be the case in a competitive market … When a price floor is set substan-
tially above marginal or incremental cost a price “umbrella” is created which
allows less efficient rivals to remain in the market sheltered from full price
competition. A fully distributed price floor may thus misallocate resources and
force consumers to pay more for less production than competition would dic-
tate.’

The court concluded by saying:

Pricing at or above long-run incremental cost in a competitive market is a ra-
tional and profitable business practice. Because there are legitimate, and in fact
compelling, business reasons for pricing products at or above their long-run in-

61 See MCI, supra note 50 at 1092.
62Ibid. at 1116-117 [footnotes and citations omitted].

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[Vol. 41

cremental cost, no predatory intent should be presumed or inferred from such
conduct

One of the arguments that MCI had advanced in support of F.D.C. was a variant
on the argument that had earlier been made by Northeastern; that is, that an FD.C.
methodology is required to prevent A.T.&T. from subsidising its competitive serv-
ices with revenues derived from monopoly services. MCI pointed out that
A.T.&T.’s Telpak and other private-line long-distance services, although they
showed a positive rate of return, earned, on an allocated rate base, a lower rate of
return than did certain other A.T.&T. long-distance services. The court rejected this
argument:

Such differing rates of return, however, even if correctly and meaningfully de-
rived, do not support the imposition of antitrust liability. The fact that different
services may earn different rates of return largely reflects the realities of a
competitive market. Where a firm faces competition, demand is more elastic –
that is, more sensitive to changes in prices – because of the presence of other
firms producing substitute products to which buyers may turn. Lower returns
on investment are to be expected in competitive markets because each firm, in
accordance with classical competitive theory and practice, will be forced to
lower prices toward marginal costs in order to maintain its market share.”

The criticisms of RD.C. are justified. What is, nevertheless, unsatisfactory
about the analyses of these appellate courts is their failure to address the threat to
competition inherent in the special market positions occupied by the telephone
companies. In effect, S.N.E.T. and A.T.&T.’s ability to disregard their indirect costs
in the pricing of their competitive services was a consequence of the existence of a
secure monopoly base from which these costs could ultimately be recovered. This
was an entirely artificial advantage sustained by public policies favouring monop-
oly in the provision of local and switched voice services.

The consequence of the application of a strict L.R.I.C. cost standard might have
been the virtual extinction of competition in the terminal-equipment and private-
line markets had it not been for the results achieved in two other contemporary
suits. In the first, MCI successfully challenged a decision by the FC.C. prohibiting
MCI from offering “Execunet” –
a “switched private line service” which was the
functional equivalent of public long-distance telephone service for many customers
in competition with A.T.&T.’ In the second action, the Department of Justice
–

61 Ibid. at 1123.
‘Ibid [footnotes omitted].
“MCI Telecommunications Corp. v. FCC, 561 E2d 365, 182 U.S. App. 367 (D.C. Cir. 1977), cert.
denied 434 U.S. 1040,98 S. Ct. 781 (1978). The EC.C. had ruled in MCI Telecommunications Corp.
v. FCC, 60 EC.C.2d 25 (1976), that MCI was not authorised to provide Execunet service. The Court
of Appeals reversed on the ground that the FC.C. had made no formal finding that the preservation of
A.T.&T.’s monopoly over public long-distance telephone service was in the public interest, or that
MCI’s existing facilities authorizations restricted it to the provision of non-switched services. For a
discussion of the case and subsequent litigation, see G.W. Brock, Telecommunication Policy for the

1995]

M.H. RYAN – COMPETITIONAND PRICE REGULATION

brought suit against A.T.&T. alleging monopolization of the I.X. market. As a con-
sequence of that suit’s settlement, A.T.&T. was divested into separate local and I.X.
companies.” The combined effect of these two measures was to deprive A.T.&T. of
its monopoly base and, therefore, eliminate much of the problem which had led to
the Northeastern and MCI cases.

One of the three appellate court judges who sat on the MCI case, Wood J., dis-
sented in part on the ground that the simple application of an L.R.I.C. cost standard
was an improper substitute for a full assessment of the defendant’s conduct in
making a determination as to whether predation had occurred. “The majority,” the
dissenting judge said, “accepts the proposition that the antitrust laws are concerned
only with efficiency and thus concludes that arguably monopolistic practices which
do not disturb efficiency should escape liability pro tanto.”‘ He continued:

While not negating the value of policy arguments based on efficiency, I am
hesitant to abandon the jurisprudence and historical texture of the antitrust laws
in order to embrace a set of seemingly hard and fast efficiency rules which pre-
sent an illusion of conceptual and empirical tidiness.”

He pointed, in particular, to the danger that

[a] monopolist producing multiple products and services may arbitrarily and
systematically shift its revenues and costs between and among competitive
products and monopoly products, resulting in widely divergent rates of return
between these two types of markets. Such a strategy is nothing more than a
disguised price reduction and serves no purpose other than to eliminate or dis-
cipline troublesome competitors. A thinly financed competitor may be vulner-
able, regardless of relative efficiency, when a monopolist is willing to tolerate
rates of return which, although profitable, are nonetheless below his normal
expectations and reflect a systematic marshalling of monopoly resources to
eliminate a competitor.69

C. The FC.C.’s Approach

There are echoes of the concerns expressed by Wood J. in the FC.C.’s approach
to predation. In 1985, for example, the FC.C. established guidelines for the pricing
of new optional calling plans (“O.C.P.s”) offered by A.T.&T. and other carriers
which it classified as “dominant”. 70 In the proceedings that led to the establishment

Information Age: From Monopoly to Competition (Cambridge, Mass.: Harvard University Press,
1994) at 135-39.

” The terms of the settlement were embodied in a consent decree, known as the Modification of Fi-
nal Judgment (“M.FJ.”). For a description of the events leading up to the M.FJ., see Brock, ibid at
149-67.

67 MCI, supra note 50 at 1177.
6Ibid at 1179.
6Ibid at 1181-182 [citations omitted].
“Guidelines for Dominant Carriers’ MTS Rates and Rate Structure Plans, 50 FR 42945 (CC

Docket No. 84-1235), F.C.C. 85-540 [hereinafter O.C.R Guidelines].

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[Vol. 41

of those guidelines, the FC.C. examined a number of costing standards which
could potentially serve as the test of just, reasonable and non-discriminatory rates
in the context of O.C.P. offerings. One of these was F.D.C. The EC.C. rejected this
standard, citing the reasoning in Northeastern and MCI. At the same time, however,
the FC.C. declined to adopt a pure incremental cost standard, choosing instead a
third option that would allow a carrier to price down to incremental cost, but only
in cases where the carrier could demonstrate that its net revenues from the service
would increase within a twelve-month period. “The rationale for this standard,” the
EC.C. said, “is that, if the [O.C.P.] increases net [long-distance] revenues over a
reasonable period, it would not create a revenue shortfall burdening non-[O.C.P.]
customers and it would not, by definition, be receiving an anti-competitive subsidy
from those customers.”7′ As such, it would be more responsive to the FC.C.’s “dual
objectives” of “granting AT&T more pricing flexibility while continuing to protect
against anti-competitive pricing”.’ The standard adopted in the O.C.P. Guidelines
decision has since been expressly incorporated in the rules governing the pricing of
new A.T.&T. service offerings established in the AT&T Price Cap Order.”‘

Local-exchange carriers (“L.E.C.s”) in the United States were initially subject
to the same net-revenue test. In their case, however, this test has since been re-
placed by a new rule which serves a very similar purpose. L.E.C.s must demon-
strate that the revenues for any new service offering will cover all direct costs of the
service plus a share of overhead costs. This share may vary from service-to-service
in response to competitive conditions. In a similar vein, in its recent decision on
Telephone Company – Cable Television Cross-Ownership Rules, the EC.C. stipu-
lated that L.E.C.s include in their calculation of the costs of new video dialtone of-
ferings a “reasonable allocation” of the common costs of shared plant.’

D. The C.R.T.C.’s Approach

Since the private-line and terminal-equipment markets in Canada were first
opened to competition in the late 1970s and early 1980s, competitors have pressed
the case that the telephone companies have priced their offerings at levels designed
to undermine competition. The C.R.T.C. has never expressly accepted these claims,
though it has sometimes ordered an increase in the impugned rates on grounds
which did not expressly recognize the validity of the predation claim.”

7 Ibid. at 42949.
lbid. at 42950.
“7See Policy and Rules Concerning Rates for Dominant Carriers, 4 FCC Rcd. 2873 at 3123-124
(1989).

” Opinion and Order on Reconsideration and Third Further Notice of Proposed Rule Making, 10

FCC Rcd. 244 at 340ff (1994).

75 See e.g.: British Columbia Telephone Company –

Interim Rate Changes and Revenue Require-
ment Proceeding for the Years 1988 and 1989 (1988), Telecom. Decision C.R.T.C. 88-2; British Co-
lumbia Telephone Company – Revenue Requirement for the Years 1988 and 1989 and Revised Cri-
teria for Extended Area Service (1988), Telecom. Decision C.R.T.C. 88-21 at 122-39; Association of
Telecommunications Competitive Suppliers and CNCP Telecommunications v. Bell Canada and Brit-

1995]

M.H. RYAN – COMPETTION AND PRICE REGULATION

The controversy surrounding the telephone companies’ pricing practices was
heightened by the Long Distance Competition decision. The new difficulties
stemmed from the fact that, as part of its decision to open the IX. market to com-
petition, the C.R.T.C. decided to loosen the rules governing the approval of rates
for the telephone companies’ I.X. services. Under the new rules, the C.R.T.C. un-
dertook to grant interim ex parte approval to proposed rates for the telephone com-
panies’ public long-distance services where the Commission was satisfied that the
proposed rates covered their costs and continued to make an acceptable level of
contribution.”

Unitel and other competitors subsequently complained to the Commission that
the telephone companies were availing themselves of the relaxed rules to reduce
their rates for I.X. services to levels that brought them below their allowed
(company-wide) rate of return, and seeking to recoup the lost revenues through in-
creases in their rates for monopoly local services. Competitors characterized this
process as unfair to them and to local subscribers. Thus, in the months following
the release of the Long Distance Competition decision, Bell Canada proposed to
lower rates for business services such as “Advantage Plus” and “WATS” by twenty-
five percent and 21.3 percent respectively, and to lower 800 service rates by 10.7
percent. The initial impact of these proposals was a net reduction in I.X. revenues
of about ninety-two million dollars annually.” Over the same period, Bell Canada
asked the Commission to approve rate increases for a variety of monopoly local
services, such as touch-tone calling and long-distance directory services, which
would yield an additional 118 million dollars in annual revenues. 8

In Re Information Requirements for Competitive Toll Filings by the Telephone
Companies,” the Commission addressed this problem by identifying specific in-
formation that telephone companies would be required to file with their rate appli-
cations. This information would be used to establish that there was compliance with
the conditions contemplated by the Long Distance Competition decision before in-
terim ex parte approvals could be granted.’

ish Columbia Telephone Company (1988), Telecom. Decision C.R.T.C. 88-9; Application by Call-Net
Telecommunications Ltd. to Review and Vary Telecom Orders CRTC 90-1000 and 90-1001 and De-
cisions dated 30 November 1990 and 24 December 1990 (1991), Telecom. Decision C.R.T.C. 91-3.
See also the decisions infra note 82.
7″See Long Distance Competition, supra note 2 at 139-40. The telephone companies were required
to show that either the loss of contribution resulting from the change would not be significant, or
where the loss of contribution would be significant, it would amount only to the elimination of
“surplus” revenues –
i.e., revenues in excess of the amount of contribution expected from that serv-
ice.

“See Response to Interrogatory BeU(CRTC)19Nov92-9 CC filed by Bell in the C.R.T.C.’s 1993
Contribution Charges proceeding. For the decision in that proceeding, see Contribution Charges Ef-
fective April 1, 1993 (1993), Telecom. Decision C.R.T.C. 93-11.

71 See letter of L.D. Hunt (Unitel) to G.G. Henter (C.R.T.C.) (4 November 1992) at 4. This letter
commented on the Bell Tariff Notice 4562 (23 October 1992).

“(1993), Telecom. Letter Decision C.R.T.C. 93-12 [hereinafter Letter Decision 93-12].

The C.R.T.C. applied Letter Decision 93-12 to Bell Canada’s subsequent application for approval

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[Vol. 41

This measure increased protections against cross-subsidization but did not re-
solve a second, equally troubling aspect of the telephone companies’ pricing strat-
egy, namely, the targeted8′ nature of telephone-company price cuts. In order to un-
derstand the nature of the problem, it is necessary to recall that, prior to the Regula-
tory Framework decision, the telephone companies did not pay explicit contribu-
tions in respect of the use of access facilities by their I.X. services; their contribu-
tion was implicit in the I.X. rate. One consequence of this was that the telephone
companies were relieved of any commercial constraint to recover contribution from
any particular I.X. service at any particular level; they could average their contri-
bution over all services or recover it from a particular sub-category of services.
This situation, Unitel alleged in comments filed with the C.R.T.C. in 1993 and
1994′ and expressed again in the Regulatory Framework proceeding,” gave the
telephone companies a degree of pricing flexibility that was unavailable to their
competitors. They used this flexibility to target price reductions on market seg-
ments where competitive entry had occurred while ignoring other market segments.
It was Unitel’s contention that the telephone companies could price below competi-
tors and squeeze them out of the market unless the telephone companies were re-
quired to impute their average contribution to each service in determining the costs
of that service and to price their services above the resulting cost floor.

One of the telephone-company filings attacked by Unitel on the basis that it did
not meet this imputation test was Bell Canada’s proposed ‘”TeleCity” service,” an
optional long-distance service that would have allowed subscribing customers
within certain urban centres to pay a special reduced rate for up to twenty-five
hours of calls to exchanges within forty miles of their home exchange. According
to calculations performed by Unitel, the market targeted by TeleCity represented
almost one-third of the market for long-distance calling within Bell Canada’s op-
erating territory. Unitel charged that the per-minute rate of five cents proposed by

of a new optional calling scheme called the “Long Distance Plan”. Utilizing the information provided
pursuant to that decision, the Commission rejected Bell Canada’s estimates of the contribution impact
of the Plan. The Commission nevertheless approved the Plan, subject to the express condition that
Bell Canada absorb the contribution impact as calculated by the Commission by deducting that
amount from any increase in local revenues that the Commission might otherwise be prepared to
grant (see (1994), Telecom. Order C.R.T.C. 94-612).

” “Targeted” pricing is a particular form of anti-competitive pricing which involves strategically re-
ducing prices for selected services. A firm that operates in all service areas can pursue a strategy of
reducing prices in the service area where competitors operate, while recovering the resulting losses in
monopoly or limited-entry service areas. In such an environment, the firm that operates in all service
areas can effectively cross-subsidize its prices in the competitive markets.

” These included the proceedings that led to: (1994), Telecom. Order C.R.T.C. 94-111 (revisions to
rates for Virtual Corporate Network service); (1994), Telecom. Order C.R.T.C. 94-152 (revisions to
rates for overseas telephone service); (1994), Telecom. Order C.R.T.C. 94-397 (revisions to rates for
N.B. Tel’s “Atlantic Business Pak” service); and (1994), Telecom. Order C.R.T.C. 94-691 (revisions
to Bell Canada’s rates for “Advantage Preferred” service).

” See Unitel Final Argument, supra note 15 at c. 2:4ff, c. 5:14ff, c. 7:lff.
“See (1993), Telecom. Order C.R.T.C. 93-1090 [hereinafter TeleCity Order 93-1090].

1995]

M.H. RYAN – COMPETITION AND PRICE REGULATION

Bell Canada was not compensatory. Unitel also pointed out that the payments com-
petitors were required to make on account of contribution, traffic switching and ag-
gregation functions performed by the telephone companies alone amounted to in
excess of twelve cents per minute. The consequence was that, even if they faced no
other costs of providing service, the competitors would lose approximately seven
cents per minute if they attempted to match the TeleCity tariff. ‘This,” as Unitel
pointed out, “is because the price paid by Unitel and others for contribution and
switching/aggregation are not reflected in the TeleCity rates.”‘,

The C.R.T.C. had considered and rejected a proposal in 1979 similar to Unitel’s
imputation test during Phase II of the Cost Inquiry.” Phase II was concerned with
identifying the requirements that should govern the approval of rates for new serv-
ices introduced by telephone companies and other carriers. The Commission had
proposed to use a “prospective incremental cost” standard for this purpose. The
Consumers’ Association of Canada (“C.A.C.”) criticized the C.R.T.C.’s proposal to
use this standard and advocated that a market price be charged to carriers’ competi-
tive services for use of the carriers’ fixed common resources for costing purposes.
In the view of the C.A.C., this was “fundamental for the prevention of predatory
pricing and the encouragement of competition in telecommunications”.” The
Commission concluded, however, that the prospective incremental-cost approach
was appropriate for the economic evaluation of a new service, and that no account
should be taken of common costs since those costs “do not vary as a result of the
introduction of the new service”. The Commission determined, however, that “the
proportion of these costs attributable to a new service should be identified on a
memorandum basis.””

In the TeleCity case, Unitel referred the Commission to evidence filed by Al-
fred Kahn on behalf of a Stentor member, AGT Limited, in the Regulatory Frame-
work proceeding. Dr. Kahn had said the following:

A competitive system is one in which all actual and potential competitors,
incumbents and new entrants, have the same opportunity to vie for the patron-
age of buyers on the basis solely of their relative efficiency in providing the
contested service or services – with “efficiency” defined in terms of giving
customers the best combination of service quality and cost. I have on occasion
referred to this condition as the “principle of competitive parity.”

Letter of L.D. Hunt (Unitel) to S. MacPherson (C.R.T.C.) (28 October 1993) at 12.
Inquiry into Telecommunications Carrier’ Costing and Accounting Procedures: Phase II –

In-
formation Requirements for New Service Tariff Filings (1979), Telecom. Decision C.R.T.C. 79-16
[hereinafter Phase II Decision].

17 Quoted ibid at 7.
” Ibid The issue was raised again in the Phase III Decision, which was concerned with the pricing
of existing services. The Commission determined, however, that the objectives of Phase III were
“limited to the identification of costs in an empirical sense, based on the principle of cost causation,
and do not include the development of rules to allocate any fixed common costs based on concepts of
fairness” (Phase IIIDecision, supra note 14 at 35).

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[Vol. 41

Special problems are raised – whether under the antitrust laws or under
regulation –
in applying this principle to a situation where one or more of the
competitors can obtain access to customers only by using facilities controlled
by one of their rivals. Such a problem is presented here: the competition is over
the provision of toll or interexchange telephone service and competitors can,
for the most part, reach customers only via AGT for most of Alberta and by
ED TEL in Edmonton. Manifestly, when one of the competitors controls access
to or the supply of an input or a facility essential to its rivals, it becomes neces-
sary to specify the terms of that access compatible with competitive parity.

The basic governing principle is simple –

it is that there be no discrimi-
nation, overt or implicit, between the rivals and, specifically, between the divi-
sion or affiliate of the company supplying the essential input and rivals requir-
ing access to it. That discrimination may be in the price or quality of intercon-
nection provided or other terms or conditions of supply, manipulation of any of
which to the unfair advantage of competitors could thwart the achievement of
competitive parity. For simplicity, I will confine my attention to price –
i.e.,
the interconnection charge (as always, including contribution) –
and to com-
petition in toll market where AGT is the supplier of local exchange service.

The requirements for competitive parity are two:

0 AGT’s own toll operations must be subject to the same access or inter-
connection charges as it imposes on its competitors, except to the extent that
the (marginal) costs of providing that service to itself and to its competitors dif-
fer, and
o AGT’s toll charges must recover both that access or interconnection
charge and the incremental costs of its own operations.89

The Commission denied the TeleCity filing on the ground that the contribution
impacts appeared to be “significantly underestimated”” but made no express refer-
ence to the Kahn evidence nor to the Unitel proposal to include contribution in de-
termining the compensatory nature of telephone company rates.

The Commission returned to the subject, however, a few weeks later in Review
of Regulatory Framework – Targeted Pricing, Anti-Competitive Pricing and Impu-
tation Test for Telephone Company Toll Filings.” In that decision, the C.R.T.C.
ruled that telephone companies should be required to impute contribution at the
same levels as competitors to the cost of providing their services and to maintain
their prices above the resulting cost floor. This approach was necessitated, in the
Commission’s view, by the imperfect state of competition in the market for I.X.
services. It identified five specific factors which contributed to this situation:

89 A.E. Kahn, Major Elements of a Competitive Telecommunications Policy (New York: National

Economic Research Associates, 1993) at 17-18.
‘” TeleCity Order 93-1090, supra note 84 at 4.
9, (1994), Telecom. Decision C.R.T.C. 94-13 [hereinafter Targeted Pricing].

1995]

M.H. RYAN – COMPETITIONAND PRICE REGULATION

(1) domination of the I.X. market by members of Stentor, former monopoly pro-

viders of that service;

(2) the integrated character of the Stentor telephone companies that provide not
only I.X. services but also own and operate the local exchanges used by them
and their rivals to originate and terminate I.X. traffic;

(3) the persistence of entry barriers in some market segments, for example, 800-

services;

(4) a rate structure under which local rates are maintained by regulatory policy be-
low the levels necessary to cover the total costs of operating local exchanges,
thereby giving rise to a need for a large contribution to the recovery of those
costs by I.X. services;

(5) customer inertia, namely, the propensity of customers to remain with the in-
cumbent carrier even when competitors offer more advantageous prices and
other terms of service.

The Commission said the following:

The Commission’s approach to targeted pricing in [the Long Distance Com-
petition decision] essentially relied on market forces. In other words, it relied
on the assumption that, to the extent that the telephone companies targeted re-
ductions at particular market segments, they would leave other non-targeted
market segments exposed to price reductions by competitors and would make
competitive entry in the non-targeted segments more attractive. The Commis-
sion’s approach was also based on the assumption that contribution discounts
would be sufficient to offset barriers to entry across market segments. Under
such a scenario, competitors could duplicate the pattern of contribution across
market segments implicit in the telephone companies’ rates by generating a
traffic mix similar to that of the telephone companies, or could take advantage
of the telephone companies’ targeting strategy by entering other, high contribu-
tion market segments left exposed by the targeting. In addition, over time, one
would expect the telephone companies to respond to entry in the high contri-
bution market segments, with the result that the difference in contribution
across market segments would be moderated.
However, based on an examination of the market as it has evolved since [the
Long Distance Competition decision], the Commission considers that the con-
tribution discounts established in that Decision, in conjunction with the current
regime for the approval of telephone company tariff filings, are not sufficient to
address concerns over targeted pricing, given barriers to entry and customer in-
ertia in the non-targeted market segments. From the perspective of a competi-
tor, contribution represents a tangible, albeit discounted, element of cost. Under
a scenario of unrestrained targeted pricing by the telephone companies, com-
petitors could be faced with a situation in which they must compete against
telephone company prices that embody a contribution amount that is lower
than the competitor contribution cost in that market segment, but where they

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[Vol. 41

are unable to generate sufficient contribution in the less competitive (and
higher contribution) markets to offset the lower contribution markets.
The Commission considers that, due to their previous status as monopoly toll
providers, the telephone companies have an established and generally pre-
dominant share in all market segments. As a result, their traffic mix, the pres-
ence of barriers to entry and the existence of customer inertia would permit
them, on a sustained basis, to recover contribution from the most highly con-
tested market segments at a level below the contribution amount [required of
competitors]. Further, the Commission is of the view that, until barriers to entry
and customer inertia in all market segments have been reduced sufficiently to
provide competitors with an opportunity to compete equally, or until contribu-
tion is reduced to levels where potential variations between high and low con-
tribution market segments is minimal, recovery of contribution by the tele-
phone companies in specific market segments that is below [the amount re-
quired of competitors] would be inconsistent with a fair competitive environ-
ment. Until such time, while recognizing that it will somewhat reduce tele-
phone company pricing flexibility, the Commission considers it necessary in
order to ensure such an environment that an imputation test be applied …’

As a result of the Commission’s subsequent decision in the Regulatory Framework
proceeding to require telephone companies to “pay” an access charge, the contribu-
tion amount now imputed to the telephone companies in determining the compensa-
tory nature of their rates will be that charge rather than the contribution charge cal-
culated under the terms of the Long Distance Competition decision.”

Conclusion

The challenge facing the C.R.T.C. in the wake of the Long Distance Competi-
tion decision has been to find a formula which allows the telephone companies
greater pricing flexibility while at the same time providing competitors with ade-
quate protection against the exploitation by telephone companies of their dominant
market position. In the Regulatory Framework decision, the Commission removed
the constraint on price increases for optional long-distance telephone services and
800 services. It also relaxed the rules governing prices for basic (that is, other than
optional) long-distance telephone services to points within North America through
the adoption of an expedited approval process for rate revisions that do not result in
an overall price increase. In addition the telephone companies have been promised
greater flexibility in the packaging of customer-specific offerings.

At the same time, the C.R.T.C. has introduced two measures aimed at making
competition fairer for competitors. Telephone-company contribution has been made

Ibid. at 7-9. Applying this test, the Commission has since rejected a number of telephone com-
pany filings (see e.g.: (1994), Telecom. Order C.R.T.C. 94-998; (1994), Telecom. Order C.R.T.C. 94-
1142). The latter was a re-filing by Bell Canada of its TeleCity proposal, first denied in TeleCity Order
93-1090.

‘9 Regulatory Framneivork, supra note 7 at 96.

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M.H. RYAN – COMPETITION AND PRICE REGULATION

explicit by splitting the telephone company rate base and by requiring the I.X. di-
vision to “pay” for use of utility services. The Commission hopes, thereby, to en-
sure equality of treatment as between the telephone companies and their competi-
tors. The Commission has at the same time made a number of important modifica-
tions to its costing system, Phase I. In particular, it has decided to reallocate costs
of jointly-used customer services equally between the telephone companies’ utility
and competitive segments. In doing so, it has opened the prospect of further, similar
changes being made to the allocation of costs of other jointly-used services. Such
measures would go a long way to correcting the inherent disadvantages I.X.C.s suf-
fer in competing with the integrated telephone companies.

The second measure is a new policy on predatory pricing in which contribution
charges are imputed to the telephone companies in determining whether or not their
services are being provided below cost. The new policy takes account of the fact
that numerous barriers to the achievement of a workably competitive market persist
that would make it inappropriate to rely upon a pure incremental-cost standard. At
the same time, the incentives to predate have been reduced. The splitting of the
telephone companies’ rate bases ensures that, if a telephone company lowers its I.X.
rates, it will be unable to “recover” that lost revenue through increased rates for
utility services, as it could in the past. In its decision of October 31, 1995, the
Commission shows that it is prepared to go beyond the protection afforded by the im-
putation test to prevent telephone company targeting of price cuts on selected I.X.
market segments. It has directed that increased revenues that the telephone companies
will earn as a consequence of the planned increases in local rates are to be passed on to
customers through across-the-board reductions in I.X. rates.”

The implementation of the process of reform mapped out in the Regulatory
Framework decision will continue. The Commission has recently announced its deci-
sion to forbear from regulating services provided by I.X.C.s. The Commission will,
undoubtedly, be considering applications from the telephone companies for forbear-
ance for their I.X. services in the future. As to the remaining telephone company serv-
ices, in its October 31 decision, the Commission repeated its intention to initiate a pro-
ceeding in 1996 to implement a price-cap scheme for the regulation of telephone-
company utility rates!’

It has sometimes been suggested that, after a brief sunset period during which
the dismantling of remaining barriers to competition could be completed, long dis-
tance markets should be completely “deregulated”, and that any issues related to
anti-competitive conduct by carriers should thereafter be left to the Director of In-
vestigation and Research for action under the Competition Act. One of the conclu-
sions that emerges from the discussion in this article is that such a move would be
premature. Although significant progress has been made since the Long Distance
Competition decision in 1992, Canadian telecommunications markets are not yet

See Split Rate Base, supra note 48 at 24.

9′ See ibid. at 30.

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workably competitive. When competition is more firmly established in all market
segments, the need for regulation will pass. However, until that stage is reached,
transitional rules are required in order to ensure that competition is given a chance
to develop.