TVA Rural Studies

Improving Rural Telecommunications Infrastructure

Bruce L. Egan
Columbia University

3. Financial Profile for Rural Telephone Companies

There are over 1300 telephone companies in the US, about 900 of which are borrowers in the federal government RUS financial assistance program. The top 53 Local Exchange Carriers (LECs) which report annually to the FCC, account for about 90% of the approximately 150M access lines in the US¹⁸. The seven Regional Bell Operating Companies (RBOCs) alone account for about 70% of all telephone lines; adding GTE and Sprint accounts for nearly 85%. However, despite the huge differences in the scale and scope of the operations among US LECs, when comparing statistics for average per line financial results between large and small companies, the data are surprisingly similar. One reason for this is that, while the larger LECs may enjoy the low average per line costs of serving large metropolitan areas and spreading fixed network costs over a large subscriber base, they also serve a considerable number of rural service areas. Similarly, while small rural LECs may serve much less dense areas overall, they too serve relatively dense towns within those rural areas. Furthermore, larger LECs tend to have a scope of operations which is very different from that of smaller LECs including investments in regional toll service network facilities and specialized and business services.

Tables 1 and 2 provide financial benchmark data for key operating ratios, costs and revenues for large and small LECs.

3.1 Operations, Investment and Expenses

A comparison of the FCC and RUS data for large and small LECs indicates that large LECs enjoy substantial capital and labor productivity advantages due to their large scale of operations and dense subscriber base. For example, large LECs support on average about 30% more telephone lines per employee than small LECs.

Average annual expenses per line are $607 for small LECs and $446 for large LECs. However this includes annual depreciation charges per line which, due to the small LECs larger investment in physical plant per line, would be expected to cause annual capital related expenses to be higher. Since depreciation expense requires no cash outlay, operations expense net of depreciation provides a better measure of relative expense performance. Net of depreciation expense, small LECs annual expense per line is $450 and the large LEC is $330.

Even though small LECs have 40% more investment per subscriber line, the annual network related expense ($128) is almost the same as for large LECs ($120). Annual customer operations expense is $70 per line for small LECs and $84 for large LECs. Corporate operations expense (i.e., overhead) per line for small LECs is $120 and for large LECs is $70. This cursory analysis of average expense data reveals that small LECs are quite efficient relative to their larger LEC counterparts when considering the on-going network and business office operations. This is especially significant considering that conventional wisdom is that there are important production cost economies associated with larger scale and scope of network operations. Overhead expense performance for smaller LECs relative to larger LECs is not good. But, per line corporate overhead involves expenses which are more easily reduced by “spreading” them over more access lines.

3.2 Revenue and Operating Margins

Chart 1 portrays major sources of revenue and expense for small LECs in average percentage terms and Table 3 provides some indication of the variability of per subscriber revenue and expense among individual firms. The data presented earlier in Table 1 showed that annual revenue per line for small LECs is $799 per year or $66 per month and corresponding amounts for large LEC revenue is $605 per year or $50 per month. Basic local monthly service charges per line are similar for both large and small LECs at about $16 per month. Regulation continues to achieve the social objective of rate parity between rural and non-rural areas for Plain Old Telephone Service (POTS). The quality of POTS service is similar with RUS companies reporting that 98.5% of residential subscribers have single party service (the remainder have shared party line service).

These average revenue numbers reflect both business and residence lines. The FCC reports that 64% of access lines for large LECs are residential, while the RUS reports that small LECs have 82% residential lines. Throughout the US, business basic local service rates are higher than residential and therefore, the basic rates for residential service for rural subscribers is somewhat higher than that for large LECs once the higher ratio of business to residential lines is accounted for.

Table 1 shows operating margins per line for small LECs of 24% of revenue ($191.37 per year), for large LECs the corresponding margin is similar at 26%. So, for now, the cash flow performance is similar for both large and small LECs.

The most important difference in the revenue streams of small and large LECs is that a whopping 67% of small LEC revenue is derived from toll and toll carrier access services, while for large LECs the number is 45%. Per dollar of household income, rural telephone subscribers spend almost twice as much on toll service than urban customers. Relative to large LECs, small LECs provide very little toll service directly, but instead share in the use of the toll network facilities of interconnected large LECs and interexchange carriers (IXCs). This is a harbinger of future problems for small LECs who have little hope of increasing their toll operations. Large LECs on the other hand, especially the RBOCs, have much to gain when the government removes restrictions into the huge interLATA toll market. Carrier access charges and toll settlements paid from larger telephone companies to smaller ones increase the ratio of toll and carrier access revenues. As competition in the industry for toll and carrier access services escalates, this very important revenue support for small telephone companies is increasingly at risk. The fact that some very high cost rural telephone companies depend on toll subsidies for their very existence represents a special problem for the future. For such companies, average loop costs can easily run two to ten times the overall rural average.

3.3 Financial Trends

Whatever the prospects for the financial future of rural LECs, the trend for the last five years is certainly a healthy one. For the time period 1989 to 1993 RUS LECs achieved an 8% increase in per line revenue and operating margins. Basic service revenue for RUS LECs increased over the period by 8% and toll and network access revenue increased by 11%. This is impressive considering that the corresponding FCC data for large LECs indicates percentage reductions in revenue per line (-10%) and operating margins per line (-18%)¹⁹.

Furthermore, investment in rural networks is proceeding apace. From 1989 to 1993 the per line investment for RUS LECs increased by 9%. The depreciation reserve ratio (an indicator of the rate of capital replacement) has steadily increased (albeit slowly 9%) from 38.1% to 41.6%. Large LECs have done somewhat better on average as depreciation reserve ratios rose considerably from about 34% to about 40% (an 18% increase). Thus, the rural LECs rate of capital recovery increased only one-half that of the large LECs over the last five years. However, the large LECs had started back in 1989 with a depreciation reserve percentage far below that of the rural LECs and are only now catching up.

That having been said, rural LECs are now at risk of stagnating and falling behind. Large LEC depreciation rates for 1993 were 7.1% compared to only 6.2% for the small LECs (about the same as it was for 1989). In 1993 the large LECs invested in capital additions at a rate of +7.5% of the total plant in service, indicating that almost all of the financing was generated internally from depreciation charges. No comparable estimate of total capital additions over time is available for RUS companies because the exact number of companies which borrow (and report) this data to RUS varies from year to year.

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Contents, 1, 2, (3), 4, 5, 6, 7, 8, Tables, Footnotes, Charts & Figures

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