November 1998 
 

Fast-Paced Changes in Technology a Problem
for Local Phone Companies

Many Say They Can’t Write Off Assets Fast Enough

Depreciating capital assets — it’s a topic accountants can talk about with interest. It’s also an important consideration for any business, but it’s something that causes most people’s eyes to glaze. If depreciation affects a company’s bottom line, however, a situation which might ultimately affect its business and even its employees, people are likely to pay a little more attention to the subject.
The issue is currently getting some attention in Minnesota because some incumbent local telephone companies say they are losing money because they can’t depreciate their expensive equipment fast enough. They’re also concerned because they must adhere to current government regulations in an area where their competitors face no restrictions. 

Fast-Changing Technology
While competition is a factor in this whole issue, it’s “not the main thing driving changes in equipment investment,” says Gene South, CEO and general manager of Lakedale Telephone Co., Annandale. “Technology is driving changes much more, especially in the last two or three years. The federal Telecommunications Act of 1996 was a ‘rocket booster’ for spurring changes in technology.”
South says Lakedale had to retain an older switch and keep depreciating it for three years even though a new switch sitting right next to it had a lot more capacity and could do everything the old switch was doing. “To get the features customers want and to meet regulatory requirements for things like local number portability, we had to make a premature investment of $2.2 million,” he says.
Robert Eddy, president of Sherburne County Rural Telephone Co., the regulated subsidiary of Connections Etc., Big Lake, says, “The incentive for a company to buy new equipment is low if it can’t depreciate its old equipment when it’s used up its value. It’s stifling the capacity of companies to keep up with what’s new.” Eddy says his company has had automatic switching equipment since 1950 and has “never fully depreciated a switch. We’ve always had to replace it before its depreciation life was over. Our history is that equipment just doesn’t last as long as the state’s depreciation schedule says it will. The equipment’s capacity is too small, manufacturers no longer support it, or it can’t be configured to current industry or regulatory requirements.”
Local phone companies are primarily concerned about depreciating central office switches, which are basically large computers and expensive software. The same obsolescence consumers see for their desktop computers also happens to switches. And now that incumbent local companies face competition, the need to change equipment may accelerate because current systems weren’t designed to handle such things as competitors leasing incumbents’ lines, for example. Though less of a factor, even wire and fiber optic cable can be a depreciation problem. In 1986, Sherburne replaced 14-year old copper wire scheduled to last 25 years. Similar numbers for depreciation are being used for fiber, though, as Eddy notes, “nobody knows how long fiber will actually last.”
Minnesota Assistant Attorney General Scott Wilensky says regulated incumbent phone companies shouldn’t be able to write off equipment faster because the pace of technological change is faster. “Companies have to make some of the same judgments about replacing technology consumers have to make. The companies don’t always have to have the latest technology just because it’s out there.” He does admit that a government-imposed mandate creates a different situation and understands that smaller companies may not have the capacity to extend the life of older equipment that larger companies have.
Nelson Updaw, manager of the Department of Public Service’s Telecommunications Unit, says some local phone companies complain to his unit about having to depreciate equipment too quickly, but also sees “some merit” to incumbent companies’ technology argument. “There have been government mandates placed on them they couldn’t have anticipated years ago which caused them to change equipment earlier than expected,” he says. 

Competition Is a Factor
Both Updaw and Wilensky agree that regulation of depreciation should end when an area has competition for local phone customers. “Some regulators think we should keep regulating depreciation even with competition,” says Updaw, “but I tell them we’re gradually getting out of the depreciation business. I don’t think there should be regulations in this area if there are a sufficient number of competitors establishing the price of local telephone service.” Wilensky says that “depreciation affects rates because there’s not significant competition for local phone service yet. Until depreciation is less important to rate-making, it still has to be reviewed. If we get to full competition, the need to regulate depreciation rates and rates themselves disappears.”
The obvious question is when that happens. “Do we have to wait until a competitor has taken half our business before we are unregulated?” asks Jim Oss, controller for Scott-Rice Telephone Co., Prior Lake. “To be competitive,” he says, “to make the playing field level, we have to have the flexibility our unregulated competitors have. We have to be able to react fast enough to keep our business. If we’re still regulated, we may not be able to do that.”
Tom Farm, president of Olsen Thielen & Co., Ltd., an accounting firm that advises a number of Minnesota telephone companies, says most small local phone companies, despite being regulated by a less intrusive alternative form of regulation (AFOR) plan, must still file the same depreciation forms as rate-of-return companies, “a step their competitors don’t have to take.”
He says “the goal of depreciation should be to equally distribute the expense of an asset over its life. Basically, that’s what the industry wants to do now that technology is shortening the life of company assets. The companies are saying they can do a better job dealing with depreciation than regulators can.”

What’s Next
The Legislature mandated that the Department of Public Service review the issue of depreciation and report back with recommendations in January, 1999. There are indications the report may contain a number of positive changes for the state’s telecommunications industry. These could include faster depreciation for central switches and the ability of companies that stay within a predetermined depreciation range to avoid the need to obtain government approval.
For Jerry Knickerbocker of the Minnesota Telephone Association, the key is keeping up with a fast-changing industry. “Companies that are regulated now can’t afford to be two or three years behind their unregulated competition when it comes to depreciation,” he says. “It may have been appropriate to handle depreciation on an individual company basis before, but as local phone service becomes unregulated, there needs to be a mechanism that reviews depreciation rates on a regular and timely basis for the whole industry.”

PROFILE:  Rural Cellular Corporation

RCC is a wireless provider with the technology to help the innocent victims of domestic violence. As a member of the Minnesota Keystone program, whose member companies donate 5 percent of pre-tax earnings to worthy causes, it’s no surprise that RCC actively provides that help. The company partnered with Motorola and the Cellular Telecommunications Industry Association Foundation to form the Wireless Alliance for Safe Families, a program to combat the often hidden crisis of family violence. This program provides cell phones, monthly access, airtime and customer service to help family programs deal with the problem in four states. In Minnesota, the alliance benefits programs in 12 northern communities. 
 
Headquartered in Alexandria, RCC provides cellular, PCS, long distance and paging services to rural markets in the Upper Midwest and New England. Formed in 1990 when five cellular partnerships merged their interests, RCC was among the first cellular companies to become profitable. It became a publicly-traded company in 1996. RCC’s consolidated customer base exceeds 205,000 and the company serves a population of 600,000 in Minnesota and 3.1 million total. RCC’s other business — Wireless Alliance, LLC — a partnership with Aerial Communications, Inc., provides PCS services to Fargo-Moorhead, Duluth-Superior, Virginia-Hibbing, Sioux Falls and Grand Forks.

True to its rural beginnings, RCC makes the majority of its donations in the communities it serves, letting on-site managers choose where the money goes. Committed to “Safety — Your Most Important Call,” an effort by the cellular industry to promote safe use of mobile wireless technologies, RCC donates safety books to schools, participates in the Safe and Sober program, and ties safety to many of its donations.

Richard Ekstrand, company CEO, says RCC “remains true to its commitment of listening to our customers and communities and providing them with the communications services and solutions they need.”