VERIZON COMMUNICATIONS INC. et al. v. FEDERAL COMMUNICATIONS COMMISSION et al.

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VERIZON COMMUNICATIONS INC. et al. v.
FEDERAL COMMUNICATIONS
COMMISSION et al.
certiorari to the united states court of appeals for
the eighth circuit
No. 00–511. Argued October 10, 2001—Decided May 13, 2002*
In order to foster competition between monopolistic carriers providing
local telephone service and companies seeking to enter local markets,
provisions of the Telecommunications Act of 1996 (Act) entitle the new
entrants to lease elements of the incumbent carriers’ local-exchange
networks, 47 U. S. C. § 251(c), and direct the Federal Communications
Commission (FCC) to prescribe methods for state utility commissions
to use in setting rates for the sharing of those elements, § 252(d). Such
“just and reasonable rates” must, inter alia, be “based on the cost
(determined without reference to a rate-of-return or other rate-based
proceeding) of providing the . . . network element.” § 252(d)(1)(A)(i).
Regulations appended to the FCC’s First Report and Order under the
Act provide, among other things, for the treatment of “cost” under
§ 252(d)(1)(A)(i) as “forward-looking economic cost,” 47 CFR § 51.505,
something distinct from the kind of historically based cost previously
relied on in valuing a rate base, see, e. g., FPC v. Hope Natural Gas Co.,
320 U. S. 591, 596–598, 605; define the “forward-looking economic cost
of an element [as] the sum of (1) the total element long-run incremen-
tal cost of the element [TELRIC,] and (2) a reasonable allocation of
forward-looking common costs,” § 51.505(a), “incurred in providing a
group of elements that “cannot be attributed directly to individual ele-
ments,” § 51.505(c)(1); and, most importantly, specify that the TELRIC
“should be measured based on the use of the most efficient telecom-
munications technology currently available and the lowest cost net-
work configuration, given the existing location of the incumbent[’s] wire
centers,” § 51.505(b)(1). The regulations also contain so-called “com-
bination” rules requiring an incumbent, upon request and compen-
sation, to perform the functions necessary to combine network ele-
*Together with No. 00–555, WorldCom, Inc., et al. v. Verizon Commu-
nications Inc. et al., No. 00–587, Federal Communications Commission
et al. v. Iowa Utilities Board et al., No. 00–590, AT&T Corp. v. Iowa
Utilities Board et al., and No. 00–602, General Communications, Inc. v.
Iowa Utilities Board et al., also on certiorari to the same court.

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468 VERIZON COMMUNICATIONS INC. v. FCC
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ments for an entrant, unless the combination is not technically feasible.
§§ 51.315(b)–(f). Challenges to the regulations, mostly by incumbent
carriers and state commissions, were consolidated in the Eighth Circuit,
which initially held, inter alia, that the FCC had no authority to control
state commissions’ ratesetting methodology and that the FCC mis-
construed § 251(c)(3)’s plain language in implementing the combination
rules. Reversing in large part in AT&T Corp. v. Iowa Utilities Bd.,
525 U. S. 366, 384–385, this Court, among its rulings, upheld the FCC’s
jurisdiction to impose a new ratesetting methodology on the States
and reinstated the principal combination rule, Rule 315(b), which for-
bids incumbents to separate currently combined network elements be-
fore leasing them to entrants who ask for them in a combined form.
On remand, the incumbents’ primary challenge went to the FCC’s rate-
setting methodology. The Eighth Circuit understood § 252(d)(1) to be
ambiguous as between “forward-looking” and “historical” cost, so that
a forward-looking ratesetting method would presumably be reason-
able, but held that § 252(d)(1) foreclosed the use of the TELRIC meth-
odology because the Act plainly required rates based on the actual,
not hypothetical, cost of providing the network element. The court also
invalidated the additional combination rules, Rules 315(c)–(f), reading
§ 251(c)(3)’s reference to “allow[ing] requesting carriers to combine . . .
elements” as unambiguously requiring requesting carriers, not pro-
viding incumbents, to do any and all combining.
Held:
1. The FCC can require state commissions to set the rates charged
by incumbents for leased elements on a forward-looking basis untied
to the incumbents’ investment. Because the incumbents have not met
their burden of showing unreasonableness to defeat the deference due
the FCC, see Chevron U. S. A. Inc. v. Natural Resources Defense Coun-
cil, Inc., 467 U. S. 837, 843–845, the Eighth Circuit’s judgment is re-
versed insofar as it invalidated TELRIC. Pp. 497–528.
(A) This Court rejects the incumbents’ argument that “cost” in
§ 252(d)(1)’s requirement that “the . . . rate . . . be . . . based on the cost
. . . of providing the . . . network element” can only mean, in plain
language and in this particular technical context, the past cost to an
incumbent of furnishing the specific network element actually, physi-
cally, to be provided, as distinct from its value or the price that would
be paid for it on the open market. At the most basic level of common
usage, “cost” has no such clear implication. A merchant asked about
the “cost” of his goods may reasonably quote their current wholesale
market price, not the cost of the items on his shelves, which he may
have bought at higher or lower prices. When the reference shifts into

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the technical realm, the incumbents are still unconvincing. “Cost” as
used in calculating the rate base under the traditional cost-of-service
method did not stand for all past capital expenditures, but at most for
those that were prudent, while prudent investment itself could be de-
nied recovery when unexpected events rendered investment useless.
Duquesne Light Co. v. Barasch, 488 U. S. 299, 312. And even when
investment was wholly includable in the rate base, ratemakers often
rejected the utilities’ “embedded costs,” their own book-value esti-
mates, which typically were geared to maximize the rate base with
high statements of past expenditures and working capital, combined
with unduly low depreciation rates. See, e. g., Hope Natural Gas Co.,
supra, at 597–598. Equally important, the incumbents’ plain-meaning
argument ignores the statutory setting in which the mandate to use
“cost” in valuing network elements occurs. First, the Act uses “cost”
as an intermediate term in the calculation of “just and reasonable rates,”
§ 252(d)(1), and it was the very point of Hope Natural Gas that regula-
tory bodies required to set rates expressed in these terms have ample
discretion to choose methodology, 320 U. S., at 602. Second, it would
be strange to think Congress tied “cost” to historical cost without a
more specific indication, when the very same sentence that requires
“cost” pricing also prohibits any reference to a “rate-of-return or other
rate-based proceeding,” § 252(d)(1), each of which has been identified
with historical cost ever since Hope Natural Gas was decided. Without
any better indication of meaning than the unadorned term, the word
“cost” in § 252(d)(1) gives ratesetting commissions broad methodological
leeway, but says little about the method to be employed. Iowa Utili-
ties Bd., supra, at 423. Pp. 497–501.
(B) Also rejected is the incumbents’ alternative argument that, be-
cause TELRIC calculates the forward-looking cost by reference to a
hypothetical, most efficient element at existing wire centers, not the
actual network element being provided, the FCC’s particular method-
ology is neither consistent with § 252(d)(1)’s plain language nor within
the zone of reasonable interpretation subject to Chevron deference.
Pp. 501–522.
(1) The term “cost” is simply too protean to support the incum-
bents’ argument that plain language bars a definition of “cost” un-
tethered to historical investment. What the incumbents call the “hypo-
thetical” element is simply the element valued in terms of a piece of
equipment an incumbent may not own. P. 501.
(2) Similarly, the claim that TELRIC exceeds reasonable in-
terpretative leeway is open to the objection that responsibility for
“just and reasonable” rates leaves methodology largely subject to dis-
cretion. E. g., Permian Basin Area Rate Cases, 390 U. S. 747, 790.

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470 VERIZON COMMUNICATIONS INC. v. FCC
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The incumbents nevertheless field three arguments, which the Court
rejects. Pp. 501–522.
(a) The incumbents argue, first, that a method of calculating
wholesale lease rates based on the costs of providing hypothetical,
most efficient elements may simulate the competition envisioned by the
Act but does not induce it. There are basically three answers to this
no-stimulation unreasonableness claim. Pp. 503–517.
(i) The basic assumption of the no-stimulation argument—
that in a perfectly efficient market, no one who can lease at a TELRIC
rate will ever build—is contrary to fact. TELRIC does not assume a
perfectly efficient wholesale market or one that is likely to resemble
perfection in any foreseeable time, cf. Iowa Utilities Bd., supra,
at 389–390, but includes several features of inefficiency that under-
mine the incumbents’ argument. First, because the FCC has qualified
any assumption of efficiency by requiring ratesetters to calculate cost
on the basis of the existing location of the incumbent’s wire centers,
§ 51.505(b)(1), certain network elements will not be priced at their most
efficient cost and configuration. Second, TELRIC rates in practice
will differ from the products of a perfectly competitive market owing
to lags in price adjustments built into the state-commission ratesetting
process. Finally, because measurement of the TELRIC is based on the
use of the most efficient telecommunications technology currently avail-
able, ibid., the marginal cost of a most efficient element that an entrant
alone has built and uses would not set a new pricing standard until it
became available to competitors as an alternative to the incumbent’s
corresponding element. Pp. 504–507.
(ii) It cannot be said that the FCC acted unreasonably in
picking TELRIC to promote the mandated competition. Comparison
of TELRIC with alternatives proposed by the incumbents as more rea-
sonable—embedded-cost methodologies, an efficient component pricing
rule, and “Ramsey pricing,” the most commonly proposed variant of
fixed-cost recovery ratesetting—are plausibly answered by the FCC’s
stated reasons to reject the alternatives, § 51.505(d); First Report and
Order ¶¶ 655, 696, 705, 709. Pp. 507–516.
(iii) The claim that TELRIC is unreasonable as a matter
of law because it simulates, but does not produce, facilities-based compe-
tition founders on fact. The entrants say that they invested $55 billion
in new facilities from 1996 through 2000, and the incumbents do not
contest the figure. A regulatory scheme that can boast such substantial
competitive capital spending in four years is not easily described as
an unreasonable way to promote competitive investment in facilities.
Pp. 516–517.

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(b) Also unavailing is the incumbents’ second reason for calling
TELRIC an unreasonable exercise of the FCC’s regulatory discretion:
the supposed incapacity of this methodology to provide enough deprecia-
tion and allowance for capital costs to induce rational competition on
the theory’s own terms. This argument rests upon a fundamentally
false premise, that the TELRIC rules limit the depreciation and capital
costs that ratesetting commissions may recognize. On the contrary,
First Report and Order ¶ 702 gave state commissions considerable dis-
cretion on these matters, specifically permitting more favorable allow-
ances for costs of capital and depreciation than were generally allowed
under traditional ratemaking practice. The incumbents’ fallback posi-
tion, that existing rates of depreciation and costs of capital are not even
reasonable starting points, is unpersuasive. This attack tends to argue
in highly general terms, whereas TELRIC rates are calculated on the
basis of individual elements. Those rates leave plenty of room for dif-
ferences in the appropriate depreciation rates and risk-adjusted capital
costs depending on the nature and technology of the specific element to
be priced. In light of the many TELRIC rates to be calculated by state
commissions across the country, the FCC’s prescription of a general
“starting point” is reasonable enough. Pp. 517–522.
(c) Finally, the incumbents’ third argument, that TELRIC is
needlessly and unreasonably complicated and impracticable, is unper-
suasive. The record suggests that TELRIC rate proceedings are sur-
prisingly smooth-running affairs, with incumbents and competitors typi-
cally presenting two conflicting economic models supported by expert
testimony, and state commissioners customarily assigning rates based
on some predictions from one model and others from its counterpart.
At bottom, battles of experts are bound to be part of any ratesetting
scheme, and the FCC was reasonable to prefer TELRIC over alter-
native fixed-cost schemes that preserve home-field advantages for the
incumbents. P. 522.
(C) The incumbents’ attempt to apply the rule of constitutional
avoidance does not present a serious question. They say that “cost”
should be construed by reference to historical investment in order to
avoid the serious constitutional question whether a methodology so
divorced from actual investment will lead to a taking of property in
violation of the Fifth (or Fourteenth) Amendment. However, they
do not argue that any particular, actual TELRIC rate is so unjust as
to be confiscatory, despite the fact that some state commissions have
already put TELRIC rates in place. This want of any rate to be re-
viewed is significant, given that this Court has never considered a
taking challenge to a ratesetting methodology without being pre-

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sented with specific rate orders alleged to be confiscatory. See, e. g.,
Duquesne, 488 U. S., at 303–304. Indeed, the general rule is that any
question about the constitutionality of ratesetting is raised by rates,
not methods. See, e. g., Hope Natural Gas Co., 320 U. S., at 602. Thus,
the policy of construing a statute to avoid constitutional questions is
presumptively out of place when construing a measure like TELRIC
that prescribes a method. The incumbents argue unpersuasively that
this action is placed outside the general rule by strong signs that tak-
ings will occur if the TELRIC interpretation of § 252(d)(1) is allowed.
First, their comparison of historical investment in local telephone
markets with the corresponding estimate of a TELRIC evaluation is
spurious because their assumed numbers are clearly wrong. Second,
they misplace their reliance on dicta in Duquesne, supra, at 315, to the
effect that there may be a taking challenge if a ratemaking body makes
opportunistic methodology changes just to minimize a utility’s return
on capital investment. There is no evidence that the decision to adopt
TELRIC was arbitrary, opportunistic, or undertaken with a confiscatory
purpose. Indeed, the indications in the record are very much to the
contrary. Pp. 523–528.
2. The FCC can require incumbents to combine elements of their
networks at the request of entrants who cannot combine themselves,
when they lease them to the entrants. Thus, the Eighth Circuit erred
in invalidating the additional combination rules, Rules 315(c)–(f ).
Pp. 528–539.
(A) The Court rejects the incumbents’ threshold objection that
the Government’s and competing carriers’ challenge to the rules invali-
dation is barred by waiver because the Iowa Utilities Bd. petition
to review the Eighth Circuit’s earlier invalidation of Rule 315(b) did
not extend to its simultaneous invalidation of Rules 315(c)–(f). The
incumbents argue that the Eighth Circuit exceeded the scope of this
Court’s mandate when it revisited the unchallenged portion of its ear-
lier holding, and that this Court should decline to reach the validity
of Rules 315(c)–(f) because doing so would encourage the sort of stra-
tegic, piecemeal litigation disapproved in Communist Party of United
States v. Subversive Activities Control Bd., 367 U. S. 1, 30–31. How-
ever, that case does not block consideration of Rules 315(c)–(f) here.
Addressing the issue now would not “make waste” of years of efforts
by the FCC or the Eighth Circuit, id., at 32, n. 8, would not threaten
to leave a constitutional ruling pointless, and would direct the Court’s
attention not to an isolated, “long-stale” procedural error by the agency,
ibid., but to the invalidation of FCC rules meant to have general and
continuing applicability. There is no indication that litigation tactics

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prompted the failure last time to appeal on these rules, which were
reexamined on remand at the Eighth Circuit’s behest, not the Govern-
ment’s nor the competing carriers’. Any issue pressed or passed upon
by a federal court is subject to this Court’s broad discretion on certio-
rari, and there are good reasons to look at Rules 315(c)–(f). The Eighth
Circuit passed on a significant issue that has been placed in a state of
flux by a split among federal cases. Pp. 528–531.
(B) The Eighth Circuit read 47 U. S. C. § 251(c)(3)’s requirement
that “[a]n incumbent . . . provide . . . network elements in a manner that
allows requesting carriers to combine such elements” as unambigu-
ously excusing incumbents from any obligation to combine provided
elements. But the language is not that plain. If Congress had treated
incumbents and entrants as equals, it probably would be plain enough
that the incumbents’ obligations stopped at furnishing an element that
could be combined. The Act, however, proceeds on the understanding
that incumbent monopolists and contending competitors are unequal.
Cf. § 251(c). And because, within the actual statutory confines, it is not
self-evident that in obligating incumbents to furnish, Congress silently
negated a duty to combine, the Court reads § 251(c)(3)’s language as
leaving open who should do the work of combination. Under Chevron,
that leaves the additional combination rules intact unless the incum-
bents can show them to be unreasonable. The Court finds, however,
that those rules reflect a reasonable reading of the statute. They are
meant to remove practical barriers to competitive entry into local-
exchange markets while avoiding serious interference with incumbent
network operations. The rules say an incumbent shall, for payment,
“perform the functions necessary,” Rules 315(c) and (d), to combine
elements in order to put a competing carrier on an equal footing with
the incumbent when the requesting carrier is unable to combine, First
Report and Order ¶ 294, when it would not place the incumbent at a
disadvantage in operating its own network, and when it would not place
other competing carriers at a competitive disadvantage, Rule 315(c)(2).
This duty is consistent with the Act’s goals of competition and non-
discrimination, and imposing it is a sensible way to reach the result the
Act requires. Pp. 531–538.
219 F. 3d 744, affirmed in part, reversed in part, and remanded.
Souter, J., delivered the opinion of the Court, in which Rehnquist,
C. J., and Stevens, Kennedy, and Ginsburg, JJ., joined, in which Scalia
and Thomas, JJ., joined as to Part III, and in which Thomas, J., also
joined as to Part IV. Breyer, J., filed an opinion concurring in part
and dissenting in part, in which Scalia, J., joined as to Part VI, post,

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474 VERIZON COMMUNICATIONS INC. v. FCC
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p. 539. O’Connor, J., took no part in the consideration or decision of
the cases.
William P. Barr argued the cause for Verizon Communica-
tions, Inc., et al., petitioners in No. 00–511, and for BellSouth
Corp. et al., respondents in Nos. 00–555, etc. With him on
the briefs were M. Edward Whelan, Patrick F. Philbin, Mi-
chael E. Glover, Mark L. Evans, Michael K. Kellogg, Henk
Brands, Charles R. Morgan, James G. Harralson, Andrew
G. McBride, Scott Delacourt, Roger K. Toppins, Gary Phil-
lips, Sean A. Lev, and Steven G. Bradbury.
Solicitor General Olson argued the cause for the federal
parties, petitioners in Nos. 00–587, etc., and respondents in
No. 00–511. With him on the briefs were Acting Solicitor
General Underwood, Acting Assistant Attorney General
Nannes, Deputy Solicitor General Wallace, Barbara Mc-
Dowell, Catherine G. O’Sullivan, Nancy C. Garrison, and
Laurence N. Bourne. David P. Murray filed briefs for re-
spondent Sprint Corporation in Nos. 00–511, etc., in support
of petitioner federal parties and in opposition to petitioners
Verizon Communications, Inc., et al.
Donald B. Verrilli, Jr., argued the cause for WorldCom,
Inc., et al., petitioners in No. 00–555 and respondents in
No. 00–511, and for AT&T Corp., petitioner in No. 00–590
and respondent in Nos. 00–511, etc. With him on the briefs
for WorldCom, Inc., et al. were Jodie L. Kelley, Ian Heath
Gershengorn, Thomas F. O’Neil III, William Single IV,
Carol Ann Bischoff, Robert M. McDowell, and Robert J.
Aamoth. David W. Carpenter, Peter D. Keisler, Stephen B.
Kinnaird, C. Frederick Beckner III, and Mark C. Rosen-
blum filed briefs for AT&T.
Briefs for respondents in Nos. 00–511, etc., were filed by
Irwin A. Popowsky for the National Association of State
Utility Consumer Advocates, by James Bradford Ramsay
and Lawrence G. Malone for the Public Service Commission
of New York et al., and by William T. Lake, John H. Har-

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Opinion of the Court
wood II, and Robert B. McKennna for Qwest Communica-
tions International, Inc.†
Justice Souter delivered the opinion of the Court.*
These cases arise under the Telecommunications Act of
1996. Each is about the power of the Federal Communi-
cations Commission to regulate a relationship between mo-
nopolistic companies providing local telephone service and
companies entering local markets to compete with the incum-
bents. Under the Act, the new entrants are entitled, among
other things, to lease elements of the local telephone net-
works from the incumbent monopolists. The issues are
whether the FCC is authorized (1) to require state utility
commissions to set the rates charged by the incumbents for
leased elements on a forward-looking basis untied to the in-
cumbents’ investment, and (2) to require incumbents to com-
bine such elements at the entrants’ request when they lease
them to the entrants. We uphold the FCC’s assumption and
exercise of authority on both issues.
I
The 1982 consent decree settling the Government’s anti-
trust suit against the American Telephone and Telegraph
Company (AT&T) divested AT&T of its local-exchange car-
riers, leaving AT&T as a long-distance and equipment com-
pany, and limiting the divested carriers to the provision of
local telephone service. United States v. American Tele-
phone & Telegraph Co., 552 F. Supp. 131 (DC 1982), aff ’d sub
nom. Maryland v. United States, 460 U. S. 1001 (1983). The
decree did nothing, however, to increase competition in the
persistently monopolistic local markets, which were thought
†Harisha J. Bastiampillai and Morton J. Posner filed a brief for
Allegiance Telecom, Inc., et al. as amici curiae urging affirmance in
No. 00–511.
*Justice Scalia joins Part III of this opinion. Justice Thomas joins
Parts III and IV.

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476 VERIZON COMMUNICATIONS INC. v. FCC
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to be the root of natural monopoly in the telecommunications
industry. See S. Benjamin, D. Lichtman, & H. Shelanski,
Telecommunications Law and Policy 682 (2001) (hereinafter
Benjamin et al.); P. Huber, M. Kellogg, & J. Thorne, Federal
Telecommunications Law § 2.1.1, pp. 84–85 (2d ed. 1999)
(hereinafter Huber et al.); W. Baumol & J. Sidak, Toward
Competition in Local Telephony 7–10 (1994); S. Breyer, Reg-
ulation and Its Reform 291–292, 314 (1982). These markets
were addressed by provisions of the Telecommunications Act
of 1996 (1996 Act or Act), Pub L. 104–104, 110 Stat. 56, that
were intended to eliminate the monopolies enjoyed by the
inheritors of AT&T’s local franchises; this objective was con-
sidered both an end in itself and an important step toward
the Act’s other goals of boosting competition in broader
markets and revising the mandate to provide universal tele-
phone service. See Benjamin et al. 716.
Two sets of related provisions for opening local markets
concern us here. First, Congress required incumbent local-
exchange carriers to share their own facilities and serv-
ices on terms to be agreed upon with new entrants in their
markets. 47 U. S. C. § 251(c) (1994 ed., Supp. V). Second,
knowing that incumbents and prospective entrants would
sometimes disagree on prices for facilities or services, Con-
gress directed the FCC to prescribe methods for state com-
missions to use in setting rates that would subject both
incumbents and entrants to the risks and incentives that
a competitive market would produce. § 252(d). The partic-
ular method devised by the FCC for setting rates to be
charged for interconnection and lease of network elements
under the Act, § 252(d)(1),1 and regulations the FCC imposed
to implement the statutory duty to share these elements,
§ 251(c)(3), are the subjects of this litigation, which must be
understood against the background of ratemaking for public
1 Section 252(d) separately provides for ratesetting with respect to re-
ciprocal compensation for interconnected facilities, § 252(d)(2), and resale,
§ 252(d)(3).

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utilities in the United States and the structure of local
exchanges made accessible by the Act.
A
Companies providing telephone service have traditionally
been regulated as monopolistic public utilities.2 See J. Bon-
bright, Principles of Public Utility Rates 3–5 (1st ed. 1961)
(hereinafter Bonbright); I. Barnes, Economics of Public Util-
ity Regulation 37–41 (1942) (hereinafter Barnes). At the
dawn of modern utility regulation, in order to offset mo-
nopoly power and ensure affordable, stable public access
to a utility’s goods or services, legislatures enacted rate
schedules to fix the prices a utility could charge. See id., at
170–173; C. Phillips, Regulation of Public Utilities 111–112,
and n. 5 (1984) (hereinafter Phillips). See, e. g., Smyth v.
Ames, 169 U. S. 466, 470–476 (1898) (statement of case);
Munn v. Illinois, 94 U. S. 113, 134 (1877). As this job be-
came more complicated, legislatures established specialized
administrative agencies, first local or state, then federal, to
set and regulate rates. Barnes 173–175; Phillips 115–117.
See, e. g., Minnesota Rate Cases, 230 U. S. 352, 433 (1913)
(Interstate Commerce Commission); Shreveport Rate Cases,
234 U. S. 342, 354–355 (1914) ( jurisdictional dispute between
ICC and Texas Railroad Commission). See generally T. Mc-
Craw, Prophets of Regulation 11–65 (1984). The familiar
mandate in the enabling Acts was to see that rates be
“just and reasonable” and not discriminatory. Barnes 289.
See, e. g., Transportation Act of 1920, 49 U. S. C. § 1(5)
(1934 ed.).
2 Nationalization, the historical policy choice for regulation of telephone
service in many other countries, was rejected in the United States.
Cohen, The Telephone Problem and the Road to Telephone Regulation in
the United States, 1876–1917, 3 J. of Policy History 42, 46, 55–56, 65 (1991)
(hereinafter Cohen); S. Vogel, Freer Markets, More Rules: Regulatory
Reform in Advanced Industrial Countries 26–27 (1996).

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478 VERIZON COMMUNICATIONS INC. v. FCC
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All rates were subject to regulation this way: retail rates
charged directly to the public and wholesale rates charged
among businesses involved in providing the goods or services
offered by the retail utility. Intrastate retail rates were
regulated by the States or municipalities, with those at
wholesale generally the responsibility of the National Gov-
ernment, since the transmission or transportation involved
was characteristically interstate.3 See Phillips 143.
Historically, the classic scheme of administrative rate-
setting at the federal level called for rates to be set out by
the regulated utility companies in proposed tariff schedules,
on the model applied to railroad carriers under the Inter-
state Commerce Act of 1887, 24 Stat. 379. After interested
parties had had notice of the proposals and a chance to com-
ment, the tariffs would be accepted by the controlling
agency so long as they were “reasonable” (or “just and rea-
sonable”) and not “unduly discriminatory.” Hale, Commis-
sions, Rates, and Policies, 53 Harv. L. Rev. 1103, 1104–1105
(1940). See, e. g., Southern Pacific Co. v. ICC, 219 U. S. 433,
445 (1911). The States generally followed this same tariff-
schedule model. Barnes 297–298. See, e. g., Smyth, supra,
at 470–476.
3 The first noteworthy federal rate-regulation statute was the Interstate
Commerce Act of 1887, 24 Stat. 379, which was principally concerned with
railroad rates but generally governed all interstate rates. It was the
model for subsequent federal public-utility statutes like the Federal Power
Act of 1920, 41 Stat. 1063, the Communications Act of 1934, 48 Stat. 1064,
the Natural Gas Act of 1938, 52 Stat. 821, and the Civil Aeronautics Act
of 1938, 52 Stat. 973. The Communications Act of 1934 created the FCC
and was the first statute to address interstate telephone regulation in
an independent and substantive way. Federal regulation in the area
had previously been undertaken incidentally to general interstate carrier
regulation under the Interstate Commerce Act. The Mann-Elkins Act
of 1910, 36 Stat. 539, was the earliest federal statute prescribing rates
for interstate and foreign telephone and telegraph carriers, as part of
revisions to railroad rates set by the ICC. See R. Vietor, Contrived Com-
petition: Regulation and Deregulation in America 171 (1994) (hereinafter
Vietor).

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The way rates were regulated as between businesses (by
the National Government) was in some respects, however,
different from regulation of rates as between businesses
and the public (at the state or local level). In wholesale
markets, the party charging the rate and the party charged
were often sophisticated businesses enjoying presumptively
equal bargaining power, who could be expected to negotiate
a “just and reasonable” rate as between the two of them.
Accordingly, in the Federal Power Act of 1920, 41 Stat. 1063,
and again in the Natural Gas Act of 1938, 52 Stat. 821, Con-
gress departed from the scheme of purely tariff-based regu-
lation and acknowledged that contracts between commercial
buyers and sellers could be used in ratesetting, 16 U. S. C.
§ 824d(d) (Federal Power Act); 15 U. S. C. § 717c(c) (Natural
Gas Act). See United Gas Pipe Line Co. v. Mobile Gas
Service Corp., 350 U. S. 332, 338–339 (1956). When commer-
cial parties did avail themselves of rate agreements, the
principal regulatory responsibility was not to relieve a con-
tracting party of an unreasonable rate, FPC v. Sierra Pacific
Power Co., 350 U. S. 348, 355 (1956) (“its improvident bar-
gain”), but to protect against potential discrimination by
favorable contract rates between allied businesses to the det-
riment of other wholesale customers. See ibid. Cf. New
York v. United States, 331 U. S. 284, 296 (1947) (“The prin-
cipal evil at which the Interstate Commerce Act was aimed
was discrimination in its various manifestations”). This
Court once summed up matters at the wholesale level this
way:
“[W]hile it may be that the Commission may not nor-
mally impose upon a public utility a rate which would
produce less than a fair return, it does not follow that
the public utility may not itself agree by contract to a
rate affording less than a fair return or that, if it does
so, it is entitled to be relieved of its improvident bargain.
In such circumstances the sole concern of the Commis-
sion would seem to be whether the rate is so low as to

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480 VERIZON COMMUNICATIONS INC. v. FCC
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adversely affect the public interest—as where it might
impair the financial ability of the public utility to con-
tinue its service, cast upon other consumers an excessive
burden, or be unduly discriminatory.” Sierra Pacific
Power Co., supra, at 355 (citation omitted).
See also United Gas Pipe Line Co., supra, at 345.
Regulation of retail rates at the state and local levels
was, on the other hand, focused more on the demand for
“just and reasonable” rates to the public than on the perils
of rate discrimination. See Barnes 298–299. Indeed, regu-
lated local telephone markets evolved into arenas of state-
sanctioned discrimination engineered by the public utility
commissions themselves in the cause of “universal service.”
Huber et al. 80–85. See also Vietor 167–185. In order to
hold down charges for telephone service in rural markets
with higher marginal costs due to lower population densities
and lesser volumes of use, urban and business users were
charged subsidizing premiums over the marginal costs of
providing their own service. See Huber et al. 84.
These cross subsidies between markets were not neces-
sarily transfers between truly independent companies, how-
ever, thanks largely to the position attained by AT&T and
its satellites. This was known as the “Bell system,” which
by the mid-20th century had come to possess overwhelming
monopoly power in all telephone markets nationwide, supply-
ing local-exchange and long-distance services as well as
equipment. Vietor 174–175. See also R. Garnet, Telephone
Enterprise: Evolution of Bell System’s Horizontal Struc-
ture, 1876–1909, pp. 160–163 (1985) (Appendix A). The same
pervasive market presence of Bell providers that made it
simple to provide cross subsidies in aid of universal service,
however, also frustrated conventional efforts to hold retail
rates down. See Huber et al. 84–85. Before the Bell sys-
tem’s predominance, regulators might have played compet-
ing carriers against one another to get lower rates for the
public, see Cohen 47–50, but the strategy became virtually

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impossible once a single company had become the only pro-
vider in nearly every town and city across the country. This
regulatory frustration led, in turn, to new thinking about
just and reasonable retail rates and ultimately to these cases.
The traditional regulatory notion of the “just and rea-
sonable” rate was aimed at navigating the straits between
gouging utility customers and confiscating utility property.
FPC v. Hope Natural Gas Co., 320 U. S. 591, 603 (1944). See
also Barnes 289–290; Bonbright 38. More than a century
ago, reviewing courts charged with determining whether
utility rates were sufficiently reasonable to avoid unconstitu-
tional confiscation took as their touchstone the revenue that
would be a “fair return” on certain utility property known
as a “rate base.” The fair rate of return was usually set as
the rate generated by similar investment property at the
time of the rate proceeding, and in Smyth v. Ames, 169 U. S.,
at 546, the Court held that the rate base must be calculated
as “the fair value of the property being used by [the utility]
for the convenience of the public.” In pegging the rate base
at “fair value,” the Smyth Court consciously rejected the
primary alternative standard, of capital actually invested to
provide the public service or good. Id., at 543–546. The
Court made this choice in large part to prevent “excessive
valuation or fictitious capitalization” from artificially in-
flating the rate base, id., at 544, lest “ ‘[t]he public . . . be
subjected to unreasonable rates in order simply that stock-
holders may earn dividends,’ ” id., at 545 (quoting Coving-
ton & Lexington Turnpike Road Co. v. Sandford, 164 U. S.
578, 596 (1896)).4
But Smyth proved to be a troublesome mandate, as Jus-
tice Brandeis, joined by Justice Holmes, famously observed
4 And the Court had no doubt who should make the sacrifice in that
situation. “ ‘If a corporation cannot maintain such a highway and earn
dividends for stockholders, it is a misfortune for it and them which the
Constitution does not require to be remedied by imposing unjust burdens
upon the public.’ ” Smyth v. Ames, 169 U. S., at 545 (citation omitted).

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482 VERIZON COMMUNICATIONS INC. v. FCC
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25 years later. Missouri ex rel. Southwestern Bell Tele-
phone Co. v. Public Serv. Comm’n of Mo., 262 U. S. 276, 292
(1923) (dissenting opinion). The Smyth Court itself had de-
scribed, without irony, the mind-numbing complexity of the
required enquiry into fair value, as the alternative to his-
torical investment:
“[I]n order to ascertain [fair] value, original cost of con-
struction, the amount expended in permanent improve-
ments, the amount and market value of its bonds and
stock, the present as compared with the original cost
of construction, the probable earning capacity of the
property under particular rates prescribed by statute,
and the sum required to meet operating expenses, are
all matters for consideration, and are to be given such
weight as may be just and right in each case. We do
not say that there may not be other matters to be re-
garded in estimating the value of the property.” 169
U. S., at 546–547.
To the bewildered, Smyth simply threw up its hands, pre-
scribing no one method for limiting use of these numbers
but declaring all such facts to be “relevant.” 5 Southwestern
Bell Telephone Co., 262 U. S., at 294–298, and n. 6 (Brandeis,
J., dissenting). What is more, the customary checks on
calculations of value in other circumstances were hard to
come by for a utility’s property; its costly facilities rarely
changed hands and so were seldom tagged with a price a
buyer would actually pay and a seller accept, id., at 292; West
v. Chesapeake & Potomac Telephone Co. of Baltimore, 295
U. S. 662, 672 (1935). Neither could reviewing courts resort
to a utility’s revenue as an index of fair value, since its reve-
5 One of the referents of value that did prove possible was current re-
placement or reproduction cost, a primitive version of the criterion chal-
lenged in these cases. See McCardle v. Indianapolis Water Co., 272 U. S.
400, 417 (1926); Goddard, The Problem of Valuation: The Evolution of Cost
of Reproduction as the Rate Base, 41 Harv. L. Rev. 564, 570–571 (1928).

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nues were necessarily determined by the rates subject to
review, with the rate of return applied to the very property
subject to valuation. Duquesne Light Co. v. Barasch, 488
U. S. 299, 309, n. 5 (1989); Hope Natural Gas Co., supra,
at 601.
Small wonder, then, that Justice Brandeis was able to dem-
onstrate how basing rates on Smyth’s galactic notion of fair
value could produce revenues grossly excessive or insuffi-
cient when gauged against the costs of capital. He gave the
example (simplified) of a $1 million plant built with promised
returns on the equity of $90,000 a year. Southwestern Bell
Telephone Co., supra, at 304–306. If the value were to fall
to $600,000 at the time of a rate proceeding, with the rate
of return on similar investments then at 6 percent, Smyth
would say a rate was not confiscatory if it returned at least
$36,000, a shortfall of $54,000 from the costs of capital. But
if the value of the plant were to rise to $1,750,000 at the time
of the rate proceeding, and the rate of return on comparable
investments stood at 8 percent, then constitutionality under
Smyth would require rates generating at least $140,000,
$50,000 above capital costs.
The upshot of Smyth, then, was the specter of utilities
forced into bankruptcy by rates inadequate to pay off the
costs of capital, even when a drop in value resulted from
general economic decline, not imprudent investment; while
in a robust economy, an investment no more prescient could
claim what seemed a rapacious return on equity invested.
Justice Brandeis accordingly advocated replacing “fair value”
with a calculation of rate base on the cost of capital pru-
dently invested in assets used for the provision of the public
good or service, and although he did not live to enjoy success,
his campaign against Smyth came to fruition in FPC v. Hope
Natural Gas Co., 320 U. S. 591 (1944).
In Hope Natural Gas, this Court disavowed the position
that the Natural Gas Act and the Constitution required fair
value as the sole measure of a rate base on which “just and

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484 VERIZON COMMUNICATIONS INC. v. FCC
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reasonable” rates were to be calculated. Id., at 601–602.
See also FPC v. Natural Gas Pipeline Co., 315 U. S. 575,
602–606 (1942) (Black, Douglas, and Murphy, JJ., concurring).
In the matter under review, the Federal Power Commission
had valued the rate base by using “actual legitimate cost”
reflecting “sound depreciation and depletion practices,” and
so had calculated a value roughly 25 percent below the figure
generated by the natural-gas company’s fair-value methods
using “estimated reproduction cost” and “trended original
cost.” Hope Natural Gas, 320 U. S., at 596–598, and nn. 4–5.
The Court upheld the Commission. “Rates which enable
the company to operate successfully, to maintain its finan-
cial integrity, to attract capital, and to compensate its in-
vestors for the risks assumed certainly cannot be condemned
as invalid, even though they might produce only a meager
return on the so-called ‘fair value’ rate base.” 6 Id., at 605.
Although Hope Natural Gas did not repudiate everything
said in Smyth, since fair value was still “the end product of
the process of rate-making,” 320 U. S., at 601, federal and
state commissions setting rates in the aftermath of Hope
Natural Gas largely abandoned the old fair-value approach
and turned to methods of calculating the rate base on the
basis of “cost.” A. Kahn, Economics of Regulations: Princi-
ples and Institutions 40–41 (1988).
“Cost” was neither self-evident nor immune to confusion,
however; witness the invocation of “reproduction cost” as a
6 The fair-value concept survived to some degree in the “used and use-
ful” qualification to the prudent-investment rule, that a utility can only
recover prudently invested capital that is being “used and useful” in
providing the public a good or service. For example, the Pennsylvania
rate statute upheld in Duquesne Light Co. v. Barasch, 488 U. S. 299 (1989),
provided that capital invested with prudence at the time but rendered
useless by unforeseen events would not be recoverable through regulated
rates, just as it would be worthless in terms of market value. Id., at
311–312, n. 7 (“The loss to utilities from prudent ultimately unsuccessful
investments under such a system is greater than under a pure prudent
investment rule, but less than under a fair value approach”).

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popular method for calculating fair value under Smyth, see
n. 5, supra, and the Federal Power Commission’s rejection
of “trended original cost” (apparently, a straight-line deriva-
tion from the cost of capital originally invested) in favor of
“actual legitimate cost,” Hope Natural Gas, supra, at 596.
Still, over time, general agreement developed on a method
that was primus inter pares, and it is essentially a modern
gloss on that method that the incumbent carriers say the
FCC should have used to set the rates at issue here.
The method worked out is not a simple calculation of rate
base as the original cost of “prudently invested” capital
that Justice Brandeis assumed, presumably by reference to
the utility’s balance sheet at the time of the rate proceed-
ing. Southwestern Bell Telephone Co., 262 U. S., at 304–306.
Rather, “cost” came to mean “cost of service,” that is, the
cost of prudently invested capital used to provide the serv-
ice. Bonbright 173; P. Garfield & W. Lovejoy, Public Utility
Economics 56 (1964). This was calculated subject to deduc-
tions for accrued depreciation and allowances for working
capital,7 see Phillips 282–283 (table 8–1) (“a typical electric
utility rate base”), naturally leading utilities to minimize
depreciation by using very slow depreciation rates (on the
assumption of long useful lives),8 and to maximize working
capital claimed as a distinct rate-base constituent.
7 Operating cash, inventory, and accounts receivable constitute typical
current assets. Current liabilities consist of accounts payable, such as
taxes, wages, rents, interest payable, and short-term debt. Because, for
example, accounts receivable may not be collected until after liabilities
come due, working capital is capital needed to pay current liabilities in
the interim. Z. Bodie & R. Merton, Finance 427 (prelim. ed. 1998).
8 For example, in 1997, regulated incumbent local-exchange carriers
had an average depreciation cycle of 14.4 years for their assets (an aver-
age depreciation cost of $127 per line as against gross plant investment
of $1,836 per line), roughly twice as long as the average cycle of 7.4
years for unregulated competitive carriers like Worldcom. Weingarten &
Stuck, Rethinking Depreciation, 28 Business Communications Review 63
(Oct. 1998).

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486 VERIZON COMMUNICATIONS INC. v. FCC
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This formula, commonly called the prudent-investment
rule, addressed the natural temptations on the utilities’ part
to claim a return on outlays producing nothing of value to
the public. It was meant, on the one hand, to discourage
unnecessary investment and the “fictitious capitalization”
feared in Smyth, 169 U. S., at 543–546, and so to protect rate-
payers from supporting excessive capacity, or abandoned,
destroyed, or phantom assets. Kahn, Tardiff, & Weisman,
Telecommunications Act at three years: an economic evalua-
tion of its implementation by the Federal Communications
Commission, 11 Information Economics & Policy 319, 330,
n. 27 (1999) (hereinafter Kahn, Telecommunications Act).
At the same time, the prudent-investment rule was intended
to give utilities an incentive to make smart investments
deserving a “fair” return, and thus to mimic natural in-
centives in competitive markets 9 (though without an eye to
fostering the actual competition by which such markets are
defined). In theory, then, the prudent-investment qualifica-
tion gave the ratepayer an important protection by mitigat-
ing the tendency of a regulated market’s lack of competition
to support monopolistic prices.
But the mitigation was too little, the prudent-investment
rule in practice often being no match for the capacity of utili-
ties having all the relevant information to manipulate the
rate base and renegotiate the rate of return every time a
rate was set. The regulatory response in some markets
was adoption of a rate-based method commonly called “price
caps,” United States Telephone Assn. v. FCC, 188 F. 3d 521,
524 (CADC 1999), as, for example, by the FCC’s setting of
maximum access charges paid to large local-exchange com-
9 In a competitive market, a company may not simply raise prices as
much as it may need to compensate for poor investments (say, in a plant
that becomes unproductive) because competitors will then undersell the
company’s goods. See N. Mankiw, Principles of Economics 308–310 (1998)
(hereinafter Mankiw).

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panies by interexchange carriers, In re Policy and Rules
Concerning Rates for Dominant Carriers, 5 FCC Rcd. 6786,
6787, ¶ 1 (1990).
The price-cap scheme starts with a rate generated by the
conventional cost-of-service formula, which it takes as a
benchmark to be decreased at an average of some 2–3 per-
cent a year to reflect productivity growth, Kahn, Telecommu-
nications Act 330–332, subject to an upward adjustment if
necessary to reflect inflation or certain unavoidable “exoge-
nous costs” on which the company is authorized to recover a
return. 5 FCC Rcd., at 6787, ¶ 5. Although the price caps
do not eliminate gamesmanship, since there are still battles
to be fought over the productivity offset and allowable exog-
enous costs, United States Telephone Assn., supra, at 524,
they do give companies an incentive “to improve productiv-
ity to the maximum extent possible,” by entitling those that
outperform the productivity offset to keep resulting profits,
5 FCC Rcd., at 6787–6788, ¶¶ 7–9. Ultimately, the goal, as
under the basic prudent-investment rule, is to encourage in-
vestment in more productive equipment.
Before the passage of the 1996 Act, the price cap was, at
the federal level, the final stage in a century of developing
ratesetting methodology. What had changed throughout
the era beginning with Smyth v. Ames was prevailing opin-
ion on how to calculate the most useful rate base, with the
disagreement between fair-value and cost advocates turning
on whether invested capital was the key to the right balance
between investors and ratepayers, and with the price-cap
scheme simply being a rate-based offset to the utilities’ ad-
vantage of superior knowledge of the facts employed in cost-
of-service ratemaking. What is remarkable about this evo-
lution of just and reasonable ratesetting, however, is what
did not change. The enduring feature of ratesetting from
Smyth v. Ames to the institution of price caps was the idea
that calculating a rate base and then allowing a fair rate of

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488 VERIZON COMMUNICATIONS INC. v. FCC
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return on it was a sensible way to identify a range of rates
that would be just and reasonable to investors and rate-
payers. Equally enduring throughout the period was dis-
satisfaction with the successive rate-based variants. From
the constancy of this dissatisfaction, one possible lesson was
drawn by Congress in the 1996 Act, which was that regula-
tion using the traditional rate-based methodologies gave
monopolies too great an advantage and that the answer lay
in moving away from the assumption common to all the
rate-based methods, that the monopolistic structure within
the discrete markets would endure.
Under the local-competition provisions of the Act, Con-
gress called for ratemaking different from any historical
practice, to achieve the entirely new objective of uprooting
the monopolies that traditional rate-based methods had
perpetuated. H. R. Conf. Rep. No. 104–230, p. 113 (1996).
A leading backer of the Act in the Senate put the new goal
this way:
“This is extraordinary in the sense of telling private
industry that this is what they have to do in order to let
the competitors come in and try to beat your economic
brains out. . . .
“It is kind of almost a jump-start. . . . I will do every-
thing I have to let you into my business, because we
used to be a bottleneck; we used to be a monopoly; we
used to control everything.
“Now, this legislation says you will not control much
of anything. You will have to allow for nondiscrimina-
tory access on an unbundled basis to the network func-
tions and services of the Bell operating companies net-
work that is at least equal in type, quality, and price to
the access [a] Bell operating company affords to itself.”
141 Cong. Rec. 15572 (1995) (remarks of Sen. Breaux
(La.) on Pub. L. 104–104).

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For the first time, Congress passed a ratesetting statute
with the aim not just to balance interests between sellers
and buyers, but to reorganize markets by rendering regu-
lated utilities’ monopolies vulnerable to interlopers, even
if that meant swallowing the traditional federal reluctance
to intrude into local telephone markets. The approach was
deliberate, through a hybrid jurisdictional scheme with the
FCC setting a basic, default methodology for use in setting
rates when carriers fail to agree, but leaving it to state
utility commissions to set the actual rates.
While the Act is like its predecessors in tying the meth-
odology to the objectives of “just and reasonable” and non-
discriminatory rates, 47 U. S. C. § 252(d)(1), it is radically
unlike all previous statutes in providing that rates be set
“without reference to a rate-of-return or other rate-based
proceeding,” § 252(d)(1)(A)(i). The Act thus appears to be
an explicit disavowal of the familiar public-utility model of
rate regulation (whether in its fair-value or cost-of-service
incarnations) presumably still being applied by many States
for retail sales, see In re Implementation of Local Competi-
tion in Telecommunications Act of 1996, 11 FCC Rcd. 15499,
15857, ¶ 704 (1996) (First Report and Order), in favor of
novel ratesetting designed to give aspiring competitors
every possible incentive to enter local retail telephone mar-
kets, short of confiscating the incumbents’ property.
B
The physical incarnation of such a market, a “local ex-
change,” is a network connecting terminals like telephones,
faxes, and modems to other terminals within a geographical
area like a city. From terminal network interface devices,
feeder wires, collectively called the “local loop,” are run to
local switches that aggregate traffic into common “trunks.”
The local loop was traditionally, and is still largely, made of
copper wire, though fiber-optic cable is also used, albeit to a

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far lesser extent than in long-haul markets.10 Just as the
loop runs from terminals to local switches, the trunks run
from the local switches to centralized, or tandem, switches,
originally worked by hand but now by computer, which oper-
ate much like railway switches, directing traffic into other
trunks. A signal is sent toward its destination terminal on
these common ways so far as necessary, then routed back
down another hierarchy of switches to the intended tele-
phone or other equipment. A local exchange is thus a trans-
portation network for communications signals, radiating like
a root system from a “central office” (or several offices for
larger areas) to individual telephones, faxes, and the like.
It is easy to see why a company that owns a local exchange
(what the Act calls an “incumbent local exchange carrier,”
47 U. S. C. § 251(h)) would have an almost insurmountable
competitive advantage not only in routing calls within the
exchange, but, through its control of this local market, in
the markets for terminal equipment and long-distance call-
ing as well. A newcomer could not compete with the incum-
bent carrier to provide local service without coming close to
replicating the incumbent’s entire existing network, the most
costly and difficult part of which would be laying down the
“last mile” of feeder wire, the local loop, to the thousands
(or millions) of terminal points in individual houses and
businesses.11 The incumbent company could also control its
local-loop plant so as to connect only with terminals it manu-
factured or selected, and could place conditions or fees (called
“access charges”) on long-distance carriers seeking to con-
10 Some loop lines employ coaxial cable and fixed wireless technologies,
but these constitute less than 1 percent of the total number of reported
local-exchange lines in the United States. FCC, Local Telephone Compe-
tition: Status as of June 30, 2001 (Feb. 27, 2002) (table 5).
11 A mininetwork connecting only some of the users in the local exchange
would be of minimal value to customers, and, correspondingly, any value
to customers would be exponentially increased with the interconnection of
more users to the network. See generally W. Arthur, Increasing Returns
and Path Dependence in the Economy 1–12 (1994).

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nect with its network. In an unregulated world, another
telecommunications carrier would be forced to comply with
these conditions, or it could never reach the customers of a
local exchange.
II
The 1996 Act both prohibits state and local regulation
that impedes the provision of “telecommunications service,”
§ 253(a),12 and obligates incumbent carriers to allow com-
petitors to enter their local markets, § 251(c). Section 251(c)
addresses the practical difficulties of fostering local compe-
tition by recognizing three strategies that a potential com-
petitor may pursue. First, a competitor entering the mar-
ket (a “requesting” carrier, § 251(c)(2)) may decide to engage
in pure facilities-based competition, that is, to build its own
network to replace or supplement the network of the in-
cumbent. If an entrant takes this course, the Act obligates
the incumbent to “interconnect” the competitor’s facilities
to its own network to whatever extent is necessary to allow
the competitor’s facilities to operate. §§ 251(a) and (c)(2).
At the other end of the spectrum, the statute permits an
entrant to skip construction and instead simply to buy and
resell “telecommunications service,” which the incumbent
has a duty to sell at wholesale. §§ 251(b)(1) and (c)(4). Be-
tween these extremes, an entering competitor may choose to
lease certain of an incumbent’s “network elements,” 13 which
12 Title 47 U. S. C. § 253(a) (1994 ed., Supp. V) provides:
“No State or local statute or regulation, or other State or local legal
requirement, may prohibit or have the effect of prohibiting the ability of
any entity to provide any interstate or intrastate telecommunications
service.”
13 “Network element” is defined as “a facility or equipment used in the
provision of a telecommunications service. Such term also includes fea-
tures, functions, and capabilities that are provided by means of such
facility or equipment, including subscriber numbers, databases, signal-
ing systems, and information sufficient for billing and collection or used
in the transmission, routing, or other provision of a telecommunications
service.” § 153(29).

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492 VERIZON COMMUNICATIONS INC. v. FCC
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the incumbent has a duty to provide “on an unbundled basis”
at terms that are “just, reasonable, and nondiscriminatory.”
§ 251(c)(3).
Since wholesale markets for companies engaged in resale,
leasing, or interconnection of facilities cannot be created
without addressing rates, Congress provided for rates to
be set either by contracts between carriers or by state util-
ity commission rate orders. §§ 252(a)–(b). Like other fed-
eral utility statutes that authorize contracts approved by a
regulatory agency in setting rates between businesses, e. g.,
16 U. S. C. § 824d(d) (Federal Power Act); 15 U. S. C. § 717c(c)
(Natural Gas Act), the Act permits incumbent and entering
carriers to negotiate private rate agreements, 47 U. S. C.
§ 252(a); 14 see also § 251(c)(1) (duty to negotiate in good faith).
State utility commissions are required to accept any such
agreement unless it discriminates against a carrier not a
party to the contract, or is otherwise shown to be contrary
to the public interest. §§ 252(e)(1) and (e)(2)(A). Carriers,
of course, might well not agree, in which case an entering
carrier has a statutory option to request mediation by a state
commission, § 252(a)(2). But the option comes with strings,
for mediation subjects the parties to the duties specified
in § 251 and the pricing standards set forth in § 252(d), as
14 Section 252(a) provides:
“(a) Agreements arrived at through negotiation
“(1) Voluntary negotiations
“Upon receiving a request for interconnection, services, or network
elements pursuant to section 251 of this title, an incumbent local ex-
change carrier may negotiate and enter into a binding agreement with
the requesting telecommunications carrier or carriers without regard
to the standards set forth in subsections (b) and (c) of section 251 of this
title. The agreement shall include a detailed schedule of itemized charges
for interconnection and each service or network element included in
the agreement. The agreement, including any interconnection agree-
ment negotiated before February 8, 1996, shall be submitted to the State
commission under subsection (e) of this section.”

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interpreted by the FCC’s regulations, § 252(e)(2)(B). These
regulations are at issue here.
As to pricing, the Act provides that when incumbent and
requesting carriers fail to agree, state commissions will set
a “just and reasonable” and “nondiscriminatory” rate for
interconnection or the lease of network elements based on
“the cost of providing the . . . network element,” which “may
include a reasonable profit.” 15 § 252(d)(1). In setting these
rates, the state commissions are, however, subject to that
important limitation previously unknown to utility regula-
tion: the rate must be “determined without reference to a
rate-of-return or other rate-based proceeding.” Ibid. In
AT&T Corp. v. Iowa Utilities Bd., 525 U. S. 366, 384–385
(1999), this Court upheld the FCC’s jurisdiction to impose a
new methodology on the States when setting these rates.
The attack today is on the legality and logic of the particular
methodology the Commission chose.
As the Act required, six months after its effective date
the FCC implemented the local-competition provisions in its
First Report and Order, which included as an appendix the
new regulations at issue. Challenges to the order, mostly
by incumbent local-exchange carriers and state commissions,
were consolidated in the United States Court of Appeals for
the Eighth Circuit. Iowa Utilities Bd. v. FCC, 120 F. 3d
753, 792 (1997), aff ’d in part and rev’d in part, 525 U. S. 366,
397 (1999). See also California v. FCC, 124 F. 3d 934, 938
(1997), rev’d in part, 525 U. S. 366, 397 (1999) (challenges to
In re Implementation of Local Competition Provisions in
Telecommunications Act of 1996, 11 FCC Rcd. 19392 (1996)
(Second Report and Order)).
So far as it bears on where we are today, the initial de-
cision by the Eighth Circuit held that the FCC had no au-
15 Rates for wholesale purchases of telecommunications services are
covered separately, and must be based on the incumbent’s retail rates.
§ 252(d)(3).

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494 VERIZON COMMUNICATIONS INC. v. FCC
Opinion of the Court
thority to control the methodology of state commissions
setting the rates incumbent local-exchange carriers could
charge entrants for network elements, 47 CFR § 51.505(b)(1)
(1997). Iowa Utilities Bd. v. FCC, supra, at 800. The
Eighth Circuit also held that the FCC misconstrued the plain
language of § 251(c)(3) in implementing a set of “combination”
rules, 47 CFR §§ 51.315(b)–(f) (1997), the most important
of which provided that “an incumbent LEC shall not sepa-
rate requested network elements that the incumbent LEC
currently combines,” § 51.315(b). 120 F. 3d, at 813. On the
other hand, the Court of Appeals accepted the FCC’s view
that the Act required no threshold ownership of facilities by
a requesting carrier, First Report and Order ¶¶ 328–340, and
upheld Rule 319, 47 CFR § 51.319 (1997), which read “net-
work elements” broadly, to require incumbent carriers to
provide not only equipment but also services and functions,
such as operations support systems (e. g., billing databases),
§ 51.319(f)(1), operator services and directory assistance,
§ 51.319(g), and vertical switching features like call-waiting
and caller I. D., First Report and Order ¶¶ 263, 413. 120 F.
3d, at 808–810.
This Court affirmed in part and in larger part reversed.
AT&T Corp. v. Iowa Utilities Bd., 525 U. S., at 397. We
reversed in upholding the FCC’s jurisdiction to “design a
pricing methodology” to bind state ratemaking commissions,
id., at 385, as well as one of the FCC’s combination rules,
Rule 315(b), barring incumbents from separating currently
combined network elements when furnishing them to en-
trants that request them in a combined form, id., at 395. We
also reversed in striking down Rule 319, holding that
its provision for blanket access to network elements was
inconsistent with the “necessary” and “impair” standards of
47 U. S. C. § 251(d)(2), 525 U. S., at 392. We affirmed the
Eighth Circuit, however, in upholding the FCC’s broad defi-
nition of network elements to be provided, id., at 387, and

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the FCC’s understanding that the Act imposed no facilities-
ownership requirement, id., at 392–393. The case then re-
turned to the Eighth Circuit. Id., at 397.
With the FCC’s general authority to establish a pricing
methodology secure, the incumbent carriers’ primary chal-
lenge on remand went to the method that the Commission
chose. There was also renewed controversy over the combi-
nation rules (Rules 315(c)–(f)) that the Eighth Circuit had
struck down along with Rule 315(b), but upon which this
Court expressed no opinion when it reversed the invalidation
of that latter rule. 219 F. 3d 744, 748 (2000).
As for the method to derive a “nondiscriminatory,” “just
and reasonable rate for network elements,” the Act requires
the FCC to decide how to value “the cost . . . of provid-
ing the . . . network element [which] may include a reason-
able profit,” although the FCC is (as already seen) forbidden
to allow any “reference to a rate-of-return or other rate-
based proceeding,” § 252(d)(1). Within the discretion left to
it after eliminating any dependence on a “rate-of-return or
other rate-based proceeding,” the Commission chose a way
of treating “cost” as “forward-looking economic cost,” 47
CFR § 51.505 (1997), something distinct from the kind of his-
torically based cost generally relied upon in valuing a rate
base after Hope Natural Gas. In Rule 505, the FCC de-
fined the “forward-looking economic cost of an element [as]
the sum of (1) the total element long-run incremental cost
of the element [TELRIC]; [and] (2) a reasonable allocation
of forward-looking common costs,” § 51.505(a), common costs
being “costs incurred in providing a group of elements
that “cannot be attributed directly to individual elements,”
§ 51.505(c)(1). Most important of all, the FCC decided that
the TELRIC “should be measured based on the use of the
most efficient telecommunications technology currently
available and the lowest cost network configuration, given
the existing location of the incumbent[’s] wire centers.”
§ 51.505(b)(1).

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496 VERIZON COMMUNICATIONS INC. v. FCC
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“The TELRIC of an element has three components, the
operating expenses, the depreciation cost, and the appropri-
ate risk-adjusted cost of capital.” First Report and Order
¶ 703 (footnote omitted). See also 47 CFR §§ 51.505(b)(2)–
(3) (1997). A concrete example may help. Assume that it
would cost $1 a year to operate a most efficient loop element;
that it would take $10 for interest payments on the capital a
carrier would have to invest to build the lowest cost loop
centered upon an incumbent carrier’s existing wire centers
(say $100, at 10 percent per annum); and that $9 would be
reasonable for depreciation on that loop (an 11-year useful
life); then the annual TELRIC for the loop element would
be $20.16
The Court of Appeals understood § 252(d)(1)’s reference
to “the cost . . . of providing the . . . network element”
to be ambiguous as between “forward-looking” and “his-
torical” cost, so that a forward-looking ratesetting method
would presumably be a reasonable implementation of the
statute. But the Eighth Circuit thought the ambiguity af-
forded no leeway beyond that, and read the Act to require
any forward-looking methodology to be “based on the incre-
mental costs that an [incumbent] actually incurs or will incur
in providing . . . the unbundled access to its specific network
elements.” 219 F. 3d, at 751–753. Hence, the Eighth Cir-
cuit held that § 252(d)(1) foreclosed the use of the TELRIC
methodology. In other words, the court read the Act as
plainly requiring rates based on the “actual” not “hypo-
thetical” “cost . . . of providing the . . . network element,”
and reasoned that TELRIC was clearly the latter. Id., at
16 The actual TELRIC rate charged to an entrant leasing the element
would be a fraction of the TELRIC figure, based on a “reasonable projec-
tion” of the entrant’s use of the element (whether on a flat or per-usage
basis) as divided by aggregate total use of the element by the entrant, the
incumbent, and any other competitor that leases it. 47 CFR § 51.511
(1997). See also First Report and Order ¶ 682.

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750–751. The Eighth Circuit added, however, that if it were
wrong and TELRIC were permitted, the claim that in pre-
scribing TELRIC the FCC had effected an unconstitutional
taking would not be “ripe” until “resulting rates have been
determined and applied.” Id., at 753–754.
The Court of Appeals also, and for the second time, in-
validated Rules 315(c)–(f), 47 CFR §§ 51.315(c)–(f) (1997), the
FCC’s so-called “additional combination” rules, apparently
for the same reason it had rejected them before, when it
struck down Rule 315(b), the main combination rule. 219
F. 3d, at 758–759. In brief, the rules require an incumbent
carrier, upon request and compensation, to “perform the
functions necessary to combine” network elements for an
entrant, unless the combination is not “technically feasible.”
Id., at 759. The Eighth Circuit read the language of
§ 251(c)(3), with its reference to “allow[ing] requesting carri-
ers to combine . . . elements,” as unambiguously requiring a
requesting carrier, not a providing incumbent, to do any and
all combining. Ibid.
Before us, the incumbent local-exchange carriers claim
error in the Eighth Circuit’s holding that a “forward-looking
cost” methodology (as opposed to the use of “historical” cost)
is consistent with § 252(d)(1), and its conclusion that the use
of the TELRIC forward-looking cost methodology presents
no “ripe” takings claim. The FCC and the entrants, on the
other side, seek review of the Eighth Circuit’s invalidation
of the TELRIC methodology and the additional combination
rules. We granted certiorari, 531 U. S. 1124 (2001), and now
affirm on the issues raised by the incumbents, and reverse
on those raised by the FCC and the entrants.
III
A
The incumbent carriers’ first attack charges the FCC with
ignoring the plain meaning of the word “cost” as it occurs

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Opinion of the Court
in the provision of § 252(d)(1) that “the just and reasonable
rate for network elements . . . shall be . . . based on the cost
(determined without reference to a rate-of-return or other
rate-based proceeding) of providing the . . . network ele-
ment . . . .” The incumbents do not argue that in theory
the statute precludes any forward-looking methodology, but
they do claim that the cost of providing a competitor with a
network element in the future must be calculated using the
incumbent’s past investment in the element and the means
of providing it. They contend that “cost” in the statute re-
fers to “historical” cost, which they define as “what was in
fact paid” for a capital asset, as distinct from “value,” or “the
price that would be paid on the open market.” Brief for
Petitioners in No. 00–511, p. 19. They say that the technical
meaning of “cost” is “past capital expenditure,” ibid., and
they suggest an equation between “historical” and “embed-
ded” costs, id., at 20, which the FCC defines as “the costs
that the incumbent LEC incurred in the past and that are
recorded in the incumbent LEC’s books of accounts,” 47 CFR
§ 51.505(d)(1) (1997). The argument boils down to the propo-
sition that “the cost of providing the network element” can
only mean, in plain language and in this particular technical
context, the past cost to an incumbent of furnishing the spe-
cific network element actually, physically, to be provided.
The incumbents have picked an uphill battle. At the most
basic level of common usage, “cost” has no such clear im-
plication. A merchant who is asked about “the cost of pro-
viding the goods” he sells may reasonably quote their cur-
rent wholesale market price, not the cost of the particular
items he happens to have on his shelves, which may have
been bought at higher or lower prices.
When the reference shifts from common speech into the
technical realm, the incumbents still have to attack uphill.
To begin with, even when we have dealt with historical costs
as a ratesetting basis, the cases have never assumed a sense

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of “cost” as generous as the incumbents seem to claim.17
“Cost” as used in calculating the rate base under the tradi-
tional cost-of-service method did not stand for all past capital
expenditures, but at most for those that were prudent, while
prudent investment itself could be denied recovery when
unexpected events rendered investment useless, Duquesne
Light Co. v. Barasch, 488 U. S., at 312. And even when in-
vestment was wholly includable in the rate base, ratemakers
often rejected the utilities’ “embedded costs,” their own
book-value estimates, which typically were geared to maxi-
mize the rate base with high statements of past expenditures
and working capital, combined with unduly low rates of de-
preciation. See, e. g., Hope Natural Gas, 320 U. S., at 597–
598. It would also be a mistake to forget that “cost” was a
term in value-based ratemaking and has figured in contem-
porary state and federal ratemaking untethered to histori-
cal valuation.18
What is equally important is that the incumbents’ plain-
meaning argument ignores the statutory setting in which
the mandate to use “cost” in valuing network elements
occurs. First, the Act uses “cost” as an intermediate term
17 Nor is it possible to argue that “cost” would have to mean past in-
curred cost if the technical context were economics. See D. Carlton &
J. Perloff, Modern Industrial Organization 50–74 (2d ed. 1994) (hereinafter
Carlton & Perloff). “Sunk costs” are unrecoverable past costs; practically
every other sort of economic “cost” is forward looking, or can be either
historical or forward looking. “Opportunity cost,” for example, is “the
value of the best forgone alternative use of the resources employed,”
id., at 56, and as such is always forward looking. See Sidak & Spulber,
Tragedy of the Telecommons: Government Pricing of Unbundled Network
Elements Under the Telecommunications Act of 1996, 97 Colum. L. Rev.
1081, 1093 (1997) (hereinafter Sidak & Spulber, Telecommons) (“Opportu-
nity costs are . . . by definition forward-looking”).
18 See, e. g., Mobil Oil Exploration & Producing Southeast, Inc. v.
United Distribution Cos., 498 U. S. 211, 224–225 (1991); Potomac Elec.
Power Co. v. ICC, 744 F. 2d 185, 193–194 (CADC 1984); Alabama Elec.
Coop., Inc. v. FERC, 684 F. 2d 20, 27 (CADC 1982). Cf. National Assn. of
Greeting Card Publishers v. Postal Service, 462 U. S. 810, 832 (1983).

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500 VERIZON COMMUNICATIONS INC. v. FCC
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in the calculation of “just and reasonable rates,” 47 U. S. C.
§ 252(d)(1), and it was the very point of Hope Natural Gas
that regulatory bodies required to set rates expressed in
these terms have ample discretion to choose methodology,
320 U. S., at 602. Second, it would have been passing
strange to think Congress tied “cost” to historical cost with-
out a more specific indication, when the very same sentence
that requires “cost” pricing also prohibits any reference to a
“rate-of-return or other rate-based proceeding,” § 252(d)(1),
each of which has been identified with historical cost ever
since Hope Natural Gas was decided.19
The fact is that without any better indication of meaning
than the unadorned term, the word “cost” in § 252(d)(1), as
in accounting generally, is “a chameleon,” Strickland v. Com-
missioner, Maine Dept. of Human Services, 96 F. 3d 542,
546 (CA1 1996), a “virtually meaningless” term, R. Estes,
Dictionary of Accounting 32 (2d ed. 1985). As Justice
Breyer put it in Iowa Utilities Bd., words like “cost” “give
ratesetting commissions broad methodological leeway; they
say little about the ‘method employed’ to determine a par-
19 The incumbents make their own plain-language argument based on
statutory context, relying on the part of § 252(d)(1)(B) which provides that
a just and reasonable rate “may include a reasonable profit.” They say
that because separate provision is made in § 252(d)(1)(A) for factoring
“cost” into the rate, “reasonable profit” may only be understood as income
above recovery of the actual cost of an incumbent’s investment. But as
the FCC has noted, “profit” may also mean “normal” profit, which is
“the total revenue required to cover all of the costs of a firm, including
its opportunity costs.” First Report and Order ¶ 699, and n. 1705 (citing
D. Pearce, MIT Dictionary of Modern Economics 310 (1994)). That is to
say, a “reasonable profit” may refer to a “normal” return based on “the
cost of obtaining debt and equity financing” prevailing in the industry.
First Report and Order ¶ 700. This latter sense of “cost” (and accordingly
“reasonable profit”) is fully incorporated in the FCC’s provisions as to
“risk-adjusted cost of capital,” namely, that “States may adjust the cost
of capital if a party demonstrates . . . that either a higher or a lower level
of cost of capital is warranted, without . . . conducting a ‘rate-of-return or
other rate based proceeding.’ ” Id., ¶ 702.

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ticular rate.” 525 U. S., at 423 (opinion concurring in part
and dissenting in part). We accordingly reach the conclu-
sion adopted by the Court of Appeals, that nothing in
§ 252(d)(1) plainly requires reference to historical investment
when pegging rates to forward-looking “cost.”
B
The incumbents’ alternative argument is that even with-
out a stern anchor in calculating “the cost . . . of providing
the . . . network element,” the particular forward-looking
methodology the FCC chose is neither consistent with the
plain language of § 252(d)(1) nor within the zone of reasonable
interpretation subject to deference under Chevron U. S. A.
Inc. v. Natural Resources Defense Council, Inc., 467 U. S.
837, 843-845 (1984). This is so, they say, because TELRIC
calculates the forward-looking cost by reference to a hypo-
thetical, most efficient element at existing wire centers, not
the actual network element being provided.
1
The short answer to the objection that TELRIC violates
plain language is much the same as the answer to the pre-
vious plain-language argument, for what the incumbents call
the “hypothetical” element is simply the element valued in
terms of a piece of equipment an incumbent may not own.
This claim, like the one just considered, is that plain language
bars a definition of “cost” untethered to historical invest-
ment, and as explained already, the term “cost” is simply too
protean to support the incumbents’ argument.
2
Similarly, the claim that TELRIC exceeds reasonable in-
terpretative leeway is open to the objection already noted,
that responsibility for “just and reasonable” rates leaves
methodology largely subject to discretion. Permian Basin
Area Rate Cases, 390 U. S. 747, 790 (1968) (“We must re-

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502 VERIZON COMMUNICATIONS INC. v. FCC
Opinion of the Court
iterate that the breadth and complexity of the Commission’s
responsibilities demand that it be given every reasonable
opportunity to formulate methods of regulation appropri-
ate for the solution of its intensely practical difficulties”).
See generally Chevron, supra, at 843–845, 866 (“When a
challenge to an agency construction of a statutory provi-
sion, fairly conceptualized, really centers on the wisdom of
the agency’s policy, rather than whether it is a reasonable
choice within a gap left open by Congress, the challenge
must fail”).20 The incumbents nevertheless field three ar-
20 While Justice Breyer does not explicitly challenge the propriety of
Chevron deference, he relies on our decision in Motor Vehicle Mfrs. Assn.
of United States, Inc. v. State Farm Mut. Automobile Ins. Co., 463 U. S.
29, 56 (1983), to argue that the FCC’s choice of TELRIC bears no “rational
connection” to the Act’s deregulatory purpose. See post, at 542, 554 (opin-
ion concurring in part and dissenting in part). State Farm involved re-
view of an agency’s “changing its course” as to the interpretation of a
statute, 463 U. S., at 42; these cases, by contrast, involve the FCC’s first
interpretation of a new statute, and so State Farm is inapposite to the
extent that it may be read as prescribing more searching judicial review
under the circumstances of that case. (Indeed, State Farm may be read
to suggest the obverse conclusion, that the FCC would have had some
more explaining to do if it had not changed its course by favoring TELRIC
over forward-looking methodologies tethered to actual costs, given Con-
gress’s clear intent to depart from past ratesetting statutes in passing the
1996 Act.)
But even on Justice Breyer’s own terms, FCC rules stressing low
wholesale prices are by no means inconsistent with the deregulatory and
competitive purposes of the Act. As we discuss below, a policy promoting
lower lease prices for expensive facilities unlikely to be duplicated reduces
barriers to entry (particularly for smaller competitors) and puts competi-
tors that can afford these wholesale prices (but not the higher prices the
incumbents would like to charge) in a position to build their own versions
of less expensive facilities that are sensibly duplicable. See n. 27, infra.
See also infra, at 515–516 (discussing FCC’s objection to Ramsey pricing).
And while it is true, as Justice Breyer says, that the Act was “deregula-
tory,” in the intended sense of departing from traditional “regulatory”
ways that coddled monopolies, see supra, at 488 (remarks of Sen. Breaux),
that deregulatory character does not necessarily require the FCC to em-
ploy passive pricing rules deferring to incumbents’ proposed methods and

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guments. They contend, first, that a method of calculating
wholesale lease rates based on the costs of providing hypo-
thetical, most efficient elements may simulate the competi-
tion envisioned by the Act but does not induce it. Second,
they argue that even if rates based on hypothetical ele-
ments could induce competition in theory, TELRIC cannot
do this, because it does not provide the depreciation and
risk-adjusted capital costs that the theory compels. Finally,
the incumbents say that even if these objections can be an-
swered, TELRIC is needlessly, and hence unreasonably, com-
plicated and impracticable.
a
The incumbents’ (and Justice Breyer’s) basic critique
of TELRIC is that by setting rates for leased network ele-
ments on the assumption of perfect competition, TELRIC
perversely creates incentives against competition in fact.
See post, at 548–551. The incumbents say that in purport-
ing to set incumbents’ wholesale prices at the level that
would exist in a perfectly competitive market (in order to
make retail prices similarly competitive), TELRIC sets rates
so low that entrants will always lease and never build net-
work elements. See post, at 549–550. And even if an en-
trant would otherwise consider building a network element
more efficient than the best one then on the market (the one
assumed in setting the TELRIC rate), it would likewise be
deterred by the prospect that its lower cost in building and
operating this new element would be immediately available
to its competitors; under TELRIC, the incumbents assert,
the lease rate for an incumbent’s existing element would in-
cost data. On the contrary, the statutory provisions obligating the incum-
bents to lease their property, § 251(c)(3), and offer their services for resale
at wholesale rates, § 251(c)(4), are consistent with the promulgation of a
ratesetting method leaving state commissions to do the work of setting
rates without any reliance on historical-cost data provided by incumbents.

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stantly drop to match the marginal cost 21 of the entrant’s
new element once built. See ante, at 550; Brief for Re-
spondents BellSouth et al. in Nos. 00–555, etc., pp. 28–29.
According to the incumbents, the result will be, not competi-
tion, but a sort of parasitic free riding, leaving TELRIC inca-
pable of stimulating the facilities-based competition intended
by Congress.
We think there are basically three answers to this no-
stimulation claim of unreasonableness: (1) the TELRIC
methodology does not assume that the relevant markets
are perfectly competitive, and the scheme includes several
features of inefficiency that undermine the plausibility of
the incumbents’ no-stimulation argument; (2) comparison of
TELRIC with alternatives proposed by the incumbents as
more reasonable are plausibly answered by the FCC’s stated
reasons to reject the alternatives; and (3) actual investment
in competing facilities since the effective date of the Act
simply belies the no-stimulation argument’s conclusion.
(1)
The basic assumption of the incumbents’ no-stimulation
argument is contrary to fact. As we explained, the argu-
ment rests on the assumption that in a perfectly efficient
market, no one who can lease at a TELRIC rate will ever
build. But TELRIC does not assume a perfectly efficient
wholesale market or one that is likely to resemble perfec-
tion in any foreseeable time. The incumbents thus make
the same mistake we attributed in a different setting to the
FCC itself. In Iowa Utilities Bd., we rejected the FCC’s
necessary-and-impair rule, 47 CFR § 51.319 (1997), which
required incumbents to lease any network element that
might reduce, however slightly, an entrant’s marginal cost of
providing a telecommunications service, as compared with
providing the service using the entrant’s own equivalent
21 “Marginal cost” is “the increase in total cost [of producing goods] that
arises from an extra unit of production.” See Mankiw 272; see also id.,
at 283–288, 312–313; Carlton & Perloff 51–52.

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element. 525 U. S., at 389–390. “In a world of perfect com-
petition, in which all carriers are providing their service at
marginal cost, the Commission’s total equating of increased
cost (or decreased quality) with ‘necessity’ and ‘impairment’
might be reasonable, but it has not established the existence
of such an ideal world.” Id., at 390.
Not only that, but the FCC has of its own accord allowed
for inefficiency in the TELRIC design in additional ways
affecting the likelihood that TELRIC will squelch com-
petition in facilities. First, the Commission has qualified
any assumption of efficiency by requiring ratesetters to cal-
culate cost on the basis of “the existing location of the incum-
bent[’s] wire centers.” 47 CFR § 51.505(b)(1) (1997). This
means that certain network elements, principally local-loop
elements, will not be priced at their most efficient cost and
configuration to the extent, say, that a shorter loop could
serve a local exchange if the incumbent’s wire centers were
relocated for a snugger fit with the current geography of
terminal locations.
Second, TELRIC rates in practice will differ from the
products of a perfectly competitive market owing to built-in
lags in price adjustments. In a perfectly competitive mar-
ket, retail prices drop instantly to the marginal cost of the
most efficient company. See Mankiw 283–288, 312–313. As
the incumbents point out, this would deter market entry be-
cause a potential entrant would know that even if it could
provide a retail service at a lower marginal cost, it would
instantly lose that competitive edge once it entered the mar-
ket and competitors adjusted to match its price. See Brief
for Respondents BellSouth et al. in Nos. 00–555, etc., at 28–
29. Wholesale TELRIC rates, however, are set by state
commissions, usually by arbitrated agreements with 3- or
4-year terms, see Brief for Respondent Qwest Communica-
tions International, Inc., in Nos. 00–511, etc., p. 39; Reply
Brief for Petitioners Worldcom, Inc., et al. 6; Reply Brief for
Respondent Sprint Corp. 7, and n. 3; Reply Brief for Peti-

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506 VERIZON COMMUNICATIONS INC. v. FCC
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tioner AT&T Corp. 11–12; and no one claims that a competi-
tor could receive immediately on demand a TELRIC rate on
a leased element at the marginal cost of the entrant who
introduces a more efficient element.
But even if a competitor could call for a new TELRIC
rate proceeding immediately upon the introduction of a more
efficient element by a competing entrant, the competitor
would not necessarily know enough to make the call; the
fact of the element’s greater efficiency would only become
apparent when reflected in lower retail prices drawing de-
mand away from existing competitors (including the incum-
bent), forcing them to look to lowering their own marginal
costs. In practice, it would take some time for the innovat-
ing entrant to install the new equipment, to engage in mar-
keting offering a lower retail price to attract business, and
to steal away enough customer subscriptions (given the lim-
ited opportunity to capture untapped customers for local
telephone service) for competitors to register the drop in
demand.
Finally, it bears reminding that the FCC prescribes meas-
urement of the TELRIC “based on the use of the most ef-
ficient telecommunications technology currently available,”
47 CFR § 51.505(b)(1) (1997). Owing to that condition of
current availability, the marginal cost of a most efficient
element that an entrant alone has built and uses would not
set a new pricing standard until it became available to com-
petitors as an alternative to the incumbent’s corresponding
element.22
22 The Michigan state commission’s September 1994 order implement-
ing a long-run incremental cost method for leasing local-exchange net-
work elements, which the FCC considered, see First Report and Order
¶ 631, and n. 1508, makes this limitation more explicit by specifying that
rates are to be set based on the costs of elements using the most efficient
technology “currently available for purchase.” Michigan Pub. Serv.
Comm’n, Re A Methodology to Determine Long Run Incremental Cost,
156 P. U. R. 4th 1, 7, 13 (1994).

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As a reviewing Court we are, of course, in no position to
assess the precise economic significance of these and other
exceptions to the perfectly functioning market that the in-
cumbents’ criticism assumes. Instead, it is enough to recog-
nize that the incumbents’ assumption may well be incorrect.
Inefficiencies built into the scheme may provide incentives
and opportunities for competitors to build their own network
elements, perhaps for reasons unrelated to pricing (such as
the possibility of expansion into data-transmission mar-
kets by deploying “broadband” technologies, cf. post, at 552
(Breyer, J., concurring in part and dissenting in part), or
the desirability of independence from an incumbent’s man-
agement and maintenance of network elements). In any
event, the significance of the incumbents’ mistake of fact may
be indicated best not by argument here, but by the evidence
of actual investment in facilities-based competition since
TELRIC went into effect, to be discussed at Part III–B–2–
a–(3), infra.23
(2)
Perhaps sensing the futility of an unsupported theoretical
attack, the incumbents make the complementary argument
that the FCC’s choice of TELRIC, whatever might be said
about it on its own terms, was unreasonable as a matter of
law because other methods of determining cost would have
done a better job of inducing competition. Having consid-
23 Justice Breyer characterizes these built-in inefficiencies as well as
provisions for state-commission discretion as to permitted costs of depreci-
ation and capital, see Part III–B–2–a–(2), infra, as “coincidences” that
have favored considerable competitive investment by sheer luck. See
post, at 552. He thus shares the assumption of an efficient market made
by the incumbents in their argument, and like the incumbents, dismisses
departures from the theoretical assumption of a perfectly competitive
market as inconsistencies rather than pragmatic recognitions. The FCC
is, of course, under no obligation to adopt a ratesetting scheme committed
to realizing perfection in economic theory, see First Report and Order
¶ 683 (rejecting pricing premised on a fully “hypothetical least-cost most
efficient network”).

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ered the proffered alternatives and the reasons the FCC
gave for rejecting them, 47 CFR § 51.505(d) (1997); First Re-
port and Order ¶¶ 630–711, we cannot say that the FCC
acted unreasonably in picking TELRIC to promote the man-
dated competition.
The incumbents present three principal alternatives for
setting rates for network elements: embedded-cost meth-
odologies, the efficient component pricing rule, and Ramsey
pricing.24 The arguments that one or another of these meth-
odologies is preferable to TELRIC share a basic claim: it was
unreasonable for the FCC to choose a method of setting rates
that fails to include, at least in theory, some additional costs
beyond what would be most efficient in the long run,25 be-
cause lease rates that incorporate such costs will do a better
job of inducing competition.26 The theory is that once an
24 Justice Breyer proposes a “less formal kind of ‘play it by ear’ sys-
tem” based on recent European Community practices as yet another alter-
native, see post, at 558; but the incumbents do not appear to have advo-
cated such an informal ratesetting scheme to the FCC, see First Report
and Order ¶¶ 630–671, nor have they argued for this alternative before
this Court. And to the extent that Justice Breyer’s proposal empha-
sizes state commissions’ discretion to vary rates according to local circum-
stances and the particulars of each case, this is a feature that is already
built into TELRIC. See infra, at 519–520.
25 In the long run, “all of a firm’s costs become variable or avoidable.”
First Report and Order ¶ 677. See also Kahn, Telecommunications Act
326 (“[A]ll costs are variable and minimized”). In general, the costs of
producing a good include variable and fixed costs. Variable costs depend
on how much of a good is produced, like the cost of copper to make a loop
which rises as the loop is made longer; fixed costs, like rent, must be paid
in any event without regard to how much is produced. See Carlton &
Perloff 51–56. The long run is a timeframe of sufficient duration that a
company has no fixed costs of production.
26 The argument that rates incorporating fixed costs are necessary to
avoid an unconstitutional taking is taken up in Part III–C, infra. Indeed,
the expert literature the incumbents rely on to advocate fixed-cost rate-
setting systems, see infra, at 514–515, do so almost exclusively on the
premise of averting unwanted confiscation, and thus offer little support

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entrant has its foot in the door, it will have a greater incen-
tive to build and operate its own more efficient network ele-
ment if the lease rates reflect something of the incumbents’
actual and inefficient marginal costs. And once the entrant
develops the element at its lower marginal cost and the retail
price drops accordingly, the incumbent will have no choice
but to innovate itself by building the most efficient ele-
ment or finding ways to reduce its marginal cost to retain
its market share.
The generic feature of the incumbents’ proposed alterna-
tives, in other words, is that some degree of long-run ineffi-
ciency ought to be preserved through the lease rates, in
order to give an entrant a more efficient alternative to leas-
ing. Of course, we have already seen that TELRIC itself
tolerates some degree of inefficient pricing in its existing
wire-center configuration requirement and through the rate-
making and development lags just described. This aside,
however, there are at least two objections that generally
undercut any desirability that such alternatives may seem to
offer over TELRIC.
The first objection turns on the fact that a lease rate that
compensates the lessor for some degree of existing ineffi-
ciency (at least from the perspective of the long run) is sim-
ply a higher rate, and the difference between such a higher
rate and the TELRIC rate could be the difference that keeps
a potential competitor from entering the market. See n. 27,
infra. Cf. First Report and Order ¶ 378 (“[I]n some areas,
the most efficient means of providing competing service may
be through the use of unbundled loops. In such cases, pre-
venting access to unbundled loops would either discourage a
potential competitor from entering the market in that area,
thereby denying those consumers the benefits of competi-
tion, or cause the competitor to construct unnecessarily du-
for the incumbents’ argument that recovery of fixed costs is a better way
to spur competition (as opposed to compensating incumbents).

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510 VERIZON COMMUNICATIONS INC. v. FCC
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plicative facilities, thereby misallocating societal resources”).
If the TELRIC rate for bottleneck elements is $100 and for
other elements (say, switches) is $10, an entering competitor
that can provide its own, more efficient switch at what
amounts to a $7 rate can enter the market for $107. If the
lease rate for the bottleneck elements were higher (say, $110)
to reflect some of the inefficiency of bottleneck elements that
actually cost the incumbent $150, then the entrant with only
$107 will be kept out. Is it better to risk keeping more
potential entrants out, or to induce them to compete in less
capital-intensive facilities with lessened incentives to build
their own bottleneck facilities? It was not obviously unrea-
sonable for the FCC to prefer the latter.27
27 Justice Breyer may be right that “firms that share existing facilities
do not compete in respect to the facilities that they share,” post, at 550 (at
least in the near future), but this is fully consistent with the FCC’s point
that entrants may need to share some facilities that are very expensive to
duplicate (say, loop elements) in order to be able to compete in other, more
sensibly duplicable elements (say, digital switches or signal-multiplexing
technology). In other words, Justice Breyer makes no accommodation
for the practical difficulty the FCC faced, that competition as to “un-
shared” elements may, in many cases, only be possible if incumbents simul-
taneously share with entrants some costly-to-duplicate elements jointly
necessary to provide a desired telecommunications service. Such is the
reality faced by the hundreds of smaller entrants (without the resources
of a large competitive carrier such as AT&T or Worldcom) seeking to gain
toeholds in local-exchange markets, see FCC, Local Telephone Competi-
tion: Status as of June 30, 2001, p. 4, n. 13. (Feb. 27, 2002) (485 firms
self-identified as competitive local-exchange carriers). Justice Breyer
elsewhere recognizes that the Act “does not require the new entrant and
incumbent to compete in respect to” elements, the “duplication of [which]
would prove unnecessarily expensive,” post, at 546. It is in just this way
that the Act allows for an entrant that may have to lease some “unneces-
sarily expensive” elements in conjunction with building its own elements
to provide a telecommunications service to consumers. In this case, low
prices for the elements to be leased become crucial in inducing the com-
petitor to enter and build. Cf. First Report and Order ¶ 630 (wholesale
prices should send “appropriate signals”).

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The second general objection turns the incumbents’ attack
on TELRIC against the incumbents’ own alternatives. If
the problem with TELRIC is that an entrant will never build
because at the instant it builds, other competitors can lease
the analogous existing (but less efficient) element from an
incumbent at a rate assuming the same most efficient mar-
ginal cost, then the same problem persists under the incum-
bents’ methods. For as soon as an entrant builds a more
efficient element, the incumbent will be forced to price to
match,28 and that rate will be available to all other competi-
tors. The point, of course, is that things are not this simple.
As we have said, under TELRIC, price adjustment is not
instantaneous in rates for a leased element corresponding to
an innovating entrant’s more efficient element; the same
would presumably be true under the incumbents’ alternative
methods, though they do not come out and say it.
Once we get into the details of the specific alternative
methods, other infirmities become evident that undermine
the claim that the FCC could not reasonably have preferred
TELRIC. As for an embedded-cost methodology, the prob-
lem with a method that relies in any part on historical cost,
the cost the incumbents say they actually incur in leasing
network elements, is that it will pass on to lessees the differ-
ence between most efficient cost and embedded cost.29 See
First Report and Order ¶ 705. Any such cost difference is
an inefficiency, whether caused by poor management result-
ing in higher operating costs or poor investment strategies
28 That is to say, if the entrant could offer a telecommunications service
at a lower retail price, competitors including the incumbent would have to
match that price by looking into ways to reduce their marginal costs, and
the incumbents’ recalibrated costs would form the basis of new lease rates.
29 In theory, embedded cost could be lower than efficient cost, see Brief
for Respondent Federal Parties 17, n. 8 (though the incumbents, under-
standably, do not avail themselves of this tack); in which case the goal
of efficient competition would be set back for the different reason of too
much market entry.

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512 VERIZON COMMUNICATIONS INC. v. FCC
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that have inflated capital and depreciation. If leased ele-
ments were priced according to embedded costs, the in-
cumbents could pass these inefficiencies to competitors in
need of their wholesale elements, and to that extent defeat
the competitive purpose of forcing efficient choices on all car-
riers whether incumbents or entrants. The upshot would
be higher retail prices consumers would have to pay. Id.,
¶¶ 655 and 705.
There are, of course, objections other than inefficiency
to any method of ratemaking that relies on embedded costs
as allegedly reflected in incumbents’ book-cost data, with
the possibilities for manipulation this presents. Even if in-
cumbents have built and are operating leased elements at
economically efficient costs, the temptation would remain to
overstate book costs to ratemaking commissions and so per-
petuate the intractable problems that led to the price-cap
innovation. See supra, at 486–487.
There is even an argument that the Act itself forbids
embedded-cost methods, and while the FCC rejected this
absolutistic reading of the statute, First Report and Order
¶ 704,30 it seems safe to say that the statutory language
places a heavy presumption against any method resem-
bling the traditional embedded-cost-of-service model of rate-
setting.31 At the very least, proposing an embedded-cost
30 “We find that the parenthetical, ‘(determined without reference to a
rate-of-return or other rate-based proceeding),’ does not further define the
type of costs that may be considered, but rather specifies a type of pro-
ceeding that may not be employed to determine the cost of interconnection
and unbundled network elements.” First Report and Order ¶ 704 (foot-
note omitted).
31 The parenthetical provision that “cost” for ratemaking purposes must
be “determined without reference to a rate-of-return or other rate-based
proceeding,” 47 U. S. C. § 252(d)(1)(A)(i), was in the Senate version of the
1996 Act, but not in the House version. S. 652, 104th Cong., 1st Sess.,
§ 251(d)(6)(A) (1995) (“[T]he charge . . . (A) shall be (i) based on the cost
(determined without reference to a rate-of-return or other rate-based pro-
ceeding) of providing the unbundled element . . .”). Both the Senate and
House bills contained additional language that was not enacted to the ef-

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alternative is a counterintuitive way to show that selecting
TELRIC was unreasonable.
Other incumbents say the FCC was unreasonable to pick
TELRIC over a method of ratesetting commonly called
the efficient component pricing rule (ECPR). See Brief for
Respondent Qwest Communications International, Inc., in
Nos. 00–511, etc., at 40–41. ECPR would base the rate for
a leased element on its most efficient long-run incremental
cost (presumably, something like the TELRIC) plus the
opportunity cost to the incumbent when the entrant leasing
fect that “rate of return regulation” would be “eliminated” or prescribing
its “abolition.” S. 652, 104th Cong., 1st Sess., § 301(a)(3) (1995) provided:
“Rate of Return Regulation Eliminated—
“(A) In instituting the price flexibility required under paragraph (1) the
Commission and the States shall establish alternative forms of regulation
for Tier 1 telecommunications carriers that do not include regulation of
the rate of return earned by such carrier . . . .”
H. R. 1555, 104th Cong., 1st Sess., § 248(b) (1995) stated:
“Notwithstanding any other provision of law, to the extent that a carrier
has complied with sections 242 and 244 of this part, the Commission, with
respect to rates for interstate or foreign communications, and State com-
missions, with respect to rates for intrastate communications, shall not
require rate-of-return regulation.”
The Commission inferred from the omission of the express prohibitions
that Congress intended to forbid a “type of proceeding” not a method.
This was a reasonable inference in light of the common practice of setting
wholesale rates by contracts incorporating retail rates set in state rate-of-
return proceedings, see, e. g., Boston Edison Co. v. FERC, 233 F. 3d 60,
62, and n. 1 (CA1 2000), though not the only one: Congress may, for exam-
ple, have balked at limiting state regulation at such a level of specificity.
Less plausible is Justice Breyer’s interpretation of the statutory lan-
guage, as “reflect[ing] Congress’ desire to obtain not perfect prices but
speedy results,” post, at 559; he concludes that the provision “specifies
that States need not use formal methods, relying instead upon bargaining
and yardstick competition,” ibid. Section 252(d)(1), however, specifies
how a state commission should set rates when an incumbent and an en-
trant fail to reach a bargain, § 252(a)(2); it seems strange, then, to read the
statutory prohibition as affirmatively urging more bargaining and regula-
tory flexibility, rather than as firing a warning shot to state commissions
to steer clear of entrenched practices perceived to perpetuate incumbent
monopolies.

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514 VERIZON COMMUNICATIONS INC. v. FCC
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the element provides a competing telecommunications serv-
ice using it. See Iowa Utilities Bd., 525 U. S., at 426
(Breyer, J., concurring in part and dissenting in part);
J. Sidak & D. Spulber, Deregulatory Takings and the Regula-
tory Contract 284–285 (1997); First Report and Order ¶ 708.
The opportunity cost is pegged to the retail revenue loss suf-
fered by the incumbent when the entrant provides the serv-
ice in its stead to its former customers. Ibid.
The FCC rejected ECPR because its calculation of oppor-
tunity cost relied on existing retail prices in monopolistic
local-exchange markets, which bore no relation to efficient
marginal cost. “We conclude that ECPR is an improper
method for setting prices of interconnection and unbundled
network elements because the existing retail prices that
would be used to compute incremental opportunity costs
under ECPR are not cost-based. Moreover, the ECPR does
not provide any mechanism for moving prices towards com-
petitive levels; it simply takes prices as given.” Id., ¶ 709.
In effect, the adjustment for opportunity cost, because it
turns on pre-existing retail prices generated by embedded
costs, would pass on the same inefficiencies and be vulnera-
ble to the same asymmetries of information in ratemaking
as a straightforward embedded-cost scheme.32
The third category of alternative methodologies proposed
focuses on costs over an intermediate term where some fixed
costs are unavoidable, as opposed to TELRIC’s long run.
See n. 25, supra (defining the long run). The fundamental
intuition underlying this method of ratesetting is that com-
petition is actually favored by allowing incumbents rate re-
32 ECPR advocates have since responded that the FCC was wrong to
assume a static tether to uncompetitive retail prices, because ECPR, prop-
erly employed, would dynamically readjust the opportunity-cost factor as
retail prices drop. Sidak & Spulber, Telecommons 1097–1098. But this
would not cure the distortions caused by passing any difference between
retail price and most efficient cost back to the incumbents as a lease
premium.

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covery of certain fixed costs efficiently incurred in the inter-
mediate term.
The most commonly proposed variant of fixed-cost recov-
ery ratesetting is “Ramsey pricing.” See Iowa Utilities
Bd., supra, at 426–427 (Breyer, J., concurring in part and
dissenting in part). Ramsey pricing was originally theo-
rized as a method of discriminatory taxation of commodities
to generate revenue with minimal discouragement of desired
consumption. Ramsey, A Contribution to the Theory of
Taxation, 37 Econ. J. 47, 58–59 (1927). The underlying prin-
ciple is that goods should be taxed or priced according to
demand: taxes or prices should be higher as to goods for
which demand is relatively inelastic. K. Train, Optimal
Regulation: The Economic Theory of Natural Monopoly 122–
125 (1991). As applied to the local-exchange wholesale mar-
ket, Ramsey pricing would allow rate recovery of certain
costs incurred by an incumbent above marginal cost, costs
associated with providing an unbundled network element
that are fixed and unavoidable over the intermediate run,
typically the 3- or 4-year term of a rate arbitration agree-
ment. The specific mechanism for recovery through whole-
sale lease rates would be to spread such costs across the
different elements to be leased according to the demand
for each particular element. First Report and Order ¶ 696.
Cf. B. Mitchell & I. Vogelsang, Telecommunications Pricing:
Theory and Practice 43–61 (1991). Thus, when demand
among entrants for loop elements is high as compared with
demand for switch elements, a higher proportion of fixed
costs would be added as a premium to the loop-element lease
rate than to the switch lease rate.
But this very feature appears to be a drawback when used
as a method of setting rates for the wholesale market in
unbundled network elements. Because the elements for
which demand among entrants will be highest are the costly
bottleneck elements, duplication of which is neither likely
nor desired, high lease rates for these elements would be

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516 VERIZON COMMUNICATIONS INC. v. FCC
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the rates most likely to deter market entry, as our earlier
example showed: if the rate for bottleneck elements went
from $100 to $110, the $107 competitor would be kept out.
This is what the FCC has said:
“[W]e conclude that an allocation methodology that re-
lies exclusively on allocating common costs in inverse
proportion to the sensitivity of demand for various net-
work elements and services may not be used. We con-
clude that such an allocation could unreasonably limit
the extent of entry into local exchange markets by allo-
cating more costs to, and thus raising the prices of, the
most critical bottleneck inputs, the demand for which
tends to be relatively inelastic. Such an allocation of
these costs would undermine the pro-competitive objec-
tives of the 1996 Act.” First Report and Order ¶ 696
(footnote omitted).
(3)
At the end of the day, theory aside, the claim that TELRIC
is unreasonable as a matter of law because it simulates but
does not produce facilities-based competition founders on
fact. The entrants have presented figures showing that
they have invested in new facilities to the tune of $55 billion
since the passage of the Act (through 2000), see Association
for Local Telecommunications Services, Local Competition
Policy & the New Economy 4 (Feb. 2, 2001); Hearing on H. R.
1542 before the House Committee on Energy and Commerce,
Ser. No. 107–24, p. 50 (2001) (statement of James H. Henry,
Managing General Partner, Greenfield Hill Capital, LLP);
see also M. Glover & D. Epps, Is the Telecommunications
Act of 1996 Working?, 52 Admin. L. Rev. 1013, 1015 (2000)
($30 billion invested through 1999). The FCC’s statistics in-
dicate substantial resort to pure and partial facilities-based
competition among the three entry strategies: as of June 30,
2001, 33 percent of entrants were using their own facilities;
23 percent were reselling services; and 44 percent were leas-

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ing network elements (26 percent of entrants leasing loops
with switching; 18 percent without switching). See FCC,
Local Telephone Competition: Status as of June 30, 2001, p. 2
(Feb. 27, 2002) (tables 3–4). The incumbents do not con-
tradict these figures, but merely speculate that the invest-
ment has not been as much as it could have been under other
ratemaking approaches, and they note that investment has
more recently shifted to nonfacilities entry options. We, of
course, have no idea whether a different forward-looking
pricing scheme would have generated even greater competi-
tive investment than the $55 billion that the entrants claim,
but it suffices to say that a regulatory scheme that can boast
such substantial competitive capital spending over a 4-year
period is not easily described as an unreasonable way to pro-
mote competitive investment in facilities.33
b
The incumbents’ second reason for calling TELRIC an
unreasonable exercise of the FCC’s regulatory discretion is
the supposed incapacity of this methodology to provide
enough depreciation and allowance for capital costs to induce
rational competition on the theory’s own terms. This chal-
lenge must be assessed against the background of utilities’
customary preference for extended depreciation schedules in
ratemaking (so as to preserve high rate bases), see n. 8,
supra; we have already noted the consequence of the utili-
ties’ approach, that the “book” value or embedded costs of
capital presented to traditional ratemaking bodies often bore
33 Nor, for that matter, does the evidence support Justice Breyer’s
assertion that TELRIC will stifle incumbents’ “incentive . . . either to
innovate or to invest” in new elements. Post, at 551. As Justice
Breyer himself notes, incumbents have invested “over $100 billion” dur-
ing the same period. Post, at 552. The figure affirms the commonsense
conclusion that so long as TELRIC brings about some competition, the
incumbents will continue to have incentives to invest and to improve their
services to hold on to their existing customer base.

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518 VERIZON COMMUNICATIONS INC. v. FCC
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little resemblance to the economic value of the capital. See
FCC Releases Audit Reports on RBOCs’ Property Records,
Report No. CC 99–3, 1999 WL 95044 (FCC, Feb. 25, 1999)
(“[B]ook costs may be overstated by approximately $5 bil-
lion”); Huber et al. 116 (We now know that “[b]y the early
1980s, the Bell System had accumulated a vast library of ac-
counting books that belonged alongside dime-store novels
and other works of fiction. . . . By 1987, it was widely esti-
mated that the book value of telephone company investments
exceeded market value by $25 billion dollars”). TELRIC
seeks to avoid this problem by basing its valuation on the
market price for most efficient elements; when rates are fig-
ured by reference to a hypothetical element instead of an
incumbent’s actual element, the incumbent gets no unfair ad-
vantage from favorable depreciation rates in the traditional
sense.
This, according to the incumbents, will be fatal to compe-
tition. Their argument is that TELRIC will result in con-
stantly changing rates based on ever cheaper, more effi-
cient technology; the incumbents will be unable to write off
each new piece of technology rapidly enough to anticipate
an even newer gadget portending a new and lower rate.
They will be stuck, they say, with sunk costs in less efficient
plant and equipment, with their investment unrecoverable
through depreciation, and their increased risk unrecognized
and uncompensated.34
34 The incumbents also contend that underdepreciation, i. e., book values
in excess of the economic value of assets, is another reason for increasing
depreciation costs under TELRIC. Brief for Petitioners in No. 00–511,
pp. 4–5. This argument is unpersuasive. As we have described, under-
depreciation (to the extent of its continuation today, which the Govern-
ment disputes, Brief for Respondent Federal Parties 38–39) was under-
taken largely by the incumbents themselves, not forced upon them by
regulators, as a means to keep the rate base inflated under the public-
utility model of regulation. See supra, at 485–487, 499. For all we know,
the incumbent carriers may yet be seeking low rates of depreciation in
state retail-rate proceedings still conducted under that model, even as

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The argument, however, rests upon a fundamentally false
premise, that the TELRIC rules limit the depreciation and
capital costs that ratesetting commissions may recognize.
In fact, TELRIC itself prescribes no fixed percentage rate
as risk-adjusted capital costs and recognizes no particular
useful life as a basis for calculating depreciation costs. On
the contrary, the FCC committed considerable discretion to
state commissions on these matters.
“Based on the current record, we conclude that the
currently authorized rate of return at the federal or
state level is a reasonable starting point for TELRIC
calculations, and incumbent LECs bear the burden of
demonstrating with specificity that the business risks
that they face in providing unbundled network elements
and interconnection services would justify a different
risk-adjusted cost of capital or depreciation rate. . . .
States may adjust the cost of capital if a party demon-
strates to a state commission that either a higher or a
lower level of cost of capital is warranted, without that
commission conducting a ‘rate-of-return or other rate
based proceeding.’ We note that the risk-adjusted cost
of capital need not be uniform for all elements. We in-
tend to re-examine the issue of the appropriate risk-
adjusted cost of capital on an ongoing basis, particularly
in light of the state commissions’ experiences in address-
ing this issue in specific situations.” First Report and
Order ¶ 702.
The order thus treated then-current capital costs and rates
of depreciation as mere starting points, to be adjusted up-
ward if the incumbents demonstrate the need. That is, for
they seek high depreciation rates here today to factor into the wholesale
prices they may charge for the same elements they use to provide retail
services. In short, the incumbents have already benefited from under-
depreciation in the calculation of retail rates, and there is no reason to
allow them further recovery through wholesale rates.

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520 VERIZON COMMUNICATIONS INC. v. FCC
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calculating leased element rates, the Commission specifically
permits more favorable allowances for costs of capital and
depreciation than were generally allowed under traditional
ratemaking practice.
The incumbents’ fallback position, that existing rates of
depreciation and costs of capital are not even reasonable
starting points, is unpersuasive. As to depreciation rates,
it is well to start by asking how serious a threat there
may be of galloping obsolescence requiring commensurately
rising depreciation rates. The answer does not support
the incumbents. The local-loop plant makes up at least
48 percent of the elements incumbents will have to pro-
vide, see id., ¶ 378, n. 818 (“As of . . . 1995 . . . [l]ocal loop
plant comprises approximately $109 billion of total plant in
service, which represents . . . 48 percent of network plant”),
and while the technology of certain other elements like
switches has evolved very rapidly in recent years, loop tech-
nology generally has gone no further than copper twisted-
pair wire and fiber-optic cable in the past couple of decades.
See n. 10, supra (less than 1 percent of local-exchange tele-
phone lines employ technologies other than copper or fiber).
We have been informed of no specter of imminently obsoles-
cent loops requiring a radical revision of currently reason-
able depreciation.35 This is significant because the FCC
found as a general matter that federally prescribed rates of
depreciation and counterparts in many States are fairly up
to date with the current state of telecommunications tech-
nologies as to different elements. See First Report and
Order ¶ 702.
35 Justice Breyer makes much of the availability of new technologies,
specifically, the use of fixed wireless and electrical conduits, see post, at
549; but the use of wireless technology in local-exchange markets is negli-
gible at present (36,000 lines in the entire Nation, less than 0.02 percent
of total lines, FCC, Local Telephone Competition: Status as of June 30,
2001 (Feb. 27, 2002) (table 5)), and the FCC has not reported any use
whatsoever of electrical conduits to provide local telecommunications
service.

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As for risk-adjusted costs of capital, competition in fact
has been slow to materialize in local-exchange retail markets
(as of June 30, 2001, the incumbents retained a 91 percent
share of the local-exchange markets, FCC, Local Telephone
Competition: Status as of June 30, 2001 (Feb. 27, 2002) (table
1)), and whether the FCC’s assumption about adequate risk
adjustment was based on hypothetical or actual competition,
it seems fair to say that the rate of 11.25 percent mentioned
by the FCC, First Report and Order ¶ 702, is a “reasonable
starting point” for return on equity calculations based on
the current lack of significant competition in local-exchange
markets.
A basic weakness of the incumbents’ attack, indeed, is
its tendency to argue in highly general terms, whereas
TELRIC rates are calculated on the basis of individual ele-
ments. TELRIC rates leave plenty of room for differences
in the appropriate depreciation rates and risk-adjusted capi-
tal costs depending on the nature and technology of the spe-
cific element to be priced (as between switches and loops, for
example). For that matter, even the blanket assumption
that on a TELRIC valuation the estimated purchase price of
a most efficient element will necessarily be lower than the
actual costs of current elements is suspect. The New York
Public Service Commission, for example, used the cost of the
more expensive fiber-optic cable as the basis for its TELRIC
loop fixed rates, notwithstanding the fact that competitors
argued that the cheaper copper-wire loop was more efficient
for voice communications and should have been the under-
lying valuation for loop rates. See 2 Lodging Material for
Respondents Worldcom, Inc., et al. 655–657 (Opinion No. 97–
2, effective Apr. 1, 1997 (Opinion and Order Setting Rates for
First Group of Network Elements)). In light of the many
different TELRIC rates to be calculated by state commis-
sions across the country, see Brief for Petitioners Worldcom,
Inc., et al. in No. 00–555, p. 21 (“millions”), the Commis-

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sion’s prescription of a general “starting point” is reason-
able enough.
c
Finally, as to the incumbents’ accusation that TELRIC is
too complicated to be practical, a criticism at least as telling
can be leveled at traditional ratemaking methodologies and
the alternatives proffered. “One important potential ad-
vantage of the T[E]LRIC approach, however is its relative
ease of calculation. Rather than estimate costs reflecting
the present [incumbent] network—a difficult task even if [in-
cumbents] provided reliable data—it is possible to generate
T[E]LRIC estimates based on a ‘green field’ approach, which
assumes construction of a network from scratch.” App. 182
(Reply Comments of the National Telecommunications and
Information Administration 24 (May 30, 1996)). To the ex-
tent that the traditional public-utility model generally relied
on embedded costs, similar sorts of complexity in reckoning
were exacerbated by an asymmetry of information, much to
the utilities’ benefit. See supra, at 486–487, 499. And what
we see from the record suggests that TELRIC rate proceed-
ings are surprisingly smooth-running affairs, with incum-
bents and competitors typically presenting two conflicting
economic models supported by expert testimony, and state
commissioners customarily assigning rates based on some
predictions from one model and others from its counterpart.
See, e. g., 1 Lodging Material for Respondents Worldcom,
Inc., et al. 146–147, 367–368 (Fla. Pub. Serv. Comm’n, In re:
Determination of cost of basic local telecommunications
service, pursuant to Section 364.025, Florida Statutes, is-
sued Jan. 7, 1999); 2 id., at 589–598, 701–704 (N. Y. Pub. Serv.
Comm’n, Opinion No. 97–2, supra). At bottom, battles of
experts are bound to be part of any ratesetting scheme, and
the FCC was reasonable to prefer TELRIC over alternative
fixed-cost schemes that preserve home-field advantages for
the incumbents.

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* * *
We cannot say whether the passage of time will show
competition prompted by TELRIC to be an illusion, but
TELRIC appears to be a reasonable policy for now, and that
is all that counts. See Chevron, 467 U. S., at 866. The in-
cumbents have failed to show that TELRIC is unreason-
able on its own terms, largely because they fall into the trap
of mischaracterizing the FCC’s departures from the assump-
tion of a perfectly competitive market (the wire-center limi-
tation, regulatory and development lags, or the refusal to
prescribe high depreciation and capital costs) as inconsisten-
cies rather than pragmatic features of the TELRIC plan.
Nor have they shown it was unreasonable for the FCC to
pick TELRIC over alternative methods, or presented evi-
dence to rebut the entrants’ figures as to the level of com-
petitive investment in local-exchange markets. In short,
the incumbents have failed to carry their burden of showing
unreasonableness to defeat the deference due the Commis-
sion. We therefore reverse the Eighth Circuit’s judgment
insofar as it invalidated TELRIC as a method for setting
rates under the Act.
C
The incumbents’ claim of TELRIC’s inherent inadequacy
to deal with depreciation or capital costs has its counterpart
in a further argument. They seek to apply the rule of con-
stitutional avoidance in saying that “cost” ought to be con-
strued by reference to historical investment in order to avoid
a serious constitutional question, whether a methodology
so divorced from investment actually made will lead to a
taking of property in violation of the Fifth (or Fourteenth)
Amendment. The Eighth Circuit did not think any such se-
rious question was in the offing, 219 F. 3d, at 753–754, and
neither do we.
At the outset, it is well to understand that the incum-
bent carriers do not present the portent of a constitutional

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524 VERIZON COMMUNICATIONS INC. v. FCC
Opinion of the Court
taking claim in the way that is usual in ratemaking cases.
They do not argue that any particular, actual TELRIC rate
is “so unjust as to be confiscatory,” that is, as threatening an
incumbent’s “financial integrity.” Duquesne Light Co., 488
U. S., at 307, 312. Indeed, the incumbent carriers have not
even presented us with an instance of TELRIC rates, which
are to be set or approved by state commissions and reviewed
in the first instance in the federal district courts, 47 U. S. C.
§§ 252(e)(4) and (e)(6). And this, despite the fact that some
States apparently have put rates in place already using
TELRIC. See First Report and Order ¶ 631 and accompa-
nying footnotes (“A number of states already employ, or have
plans to utilize, some form of [long-run incremental cost]
methodology in their approach to setting prices for unbun-
dled network elements”).
This want of any rate to be reviewed is significant, given
that this Court has never considered a taking challenge on
a ratesetting methodology without being presented with
specific rate orders alleged to be confiscatory. See, e. g., Du-
quesne Light Co., supra, at 303–304 (denial of $3.5 million
and $15.4 million increases to rate bases of electric utilities);
Smyth v. Ames, 169 U. S., at 470–476 (Nebraska carrier-rate
tariff schedule alleged to effect a taking). Granted, the
Court has never strictly held that a utility must have rates
in hand before it can claim that the adoption of a new method
of setting rates will necessarily produce an unconstitutional
taking, but that has been the implication of much the Court
has said. See Hope Natural Gas Co., 320 U. S., at 602 (“The
fact that the method employed to reach [just and reasonable
rates] may contain infirmities is not . . . important”); Natural
Gas Pipeline Co., 315 U. S., at 586 (“The Constitution does
not bind rate-making bodies to the service of any single for-
mula or combination of formulas”); Los Angeles Gas & Elec.
Corp. v. Railroad Comm’n of Cal., 289 U. S. 287, 305 (1933)
(“[M]indful of its distinctive function in the enforcement of
constitutional rights, the Court has refused to be bound by

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any artificial rule or formula which changed conditions might
upset”). Undeniably, then, the general rule is that any ques-
tion about the constitutionality of ratesetting is raised by
rates, not methods, and this means that the policy of constru-
ing a statute to avoid constitutional questions where possible
is presumptively out of place when construing statutes pre-
scribing methods.
The incumbents say this action is one of the rare ones
placed outside the general rule by signs, too strong to ignore,
that takings will occur if the TELRIC interpretation of
§ 252(d)(1) is allowed. First, they compare, at the level of
the entire network (as opposed to element-by-element), in-
dustry balance-sheet indications of historical investment in
local telephone markets with the corresponding estimate of
a TELRIC evaluation of the cost to build a new and efficient
national system of local exchanges providing universal serv-
ice. Brief for Petitioners in No. 00–511, at 10–11, and n. 6.
As against an estimated $180 billion for such a new system,
the incumbents juxtapose a value representing “total plant”
on the industry balance sheet for 1999 of roughly $342 billion.
They argue that the huge and unreasonable difference is
proof that TELRIC will necessarily result in confiscatory
rates. Ibid. (citing FCC, 1999 Statistics of Communications
Common Carriers 51 (Aug. 1, 2000) (table 2.9, line no. 32)).
The comparison, however, is spurious because the numbers
assumed by the incumbents are clearly wrong. On the one
side, the $180 billion is supposed to be based on constructing
a barebones universal-service telephone network, and so it
fails to cover elements associated with more advanced tele-
communications services that incumbents are required to
provide by lease under 47 U. S. C. § 251(c)(3). See Applica-
tion by Bell Atlantic New York for Authorization under
Section 271 of the Communications Act, 15 FCC Rcd. 3953,
¶ 245 (1999), aff ’d, 220 F. 3d 607 (CADC 2000). See also In
re Federal-State Joint Bd. on Universal Serv., 14 FCC Rcd.
20432, ¶ 41, and n. 125 (1999) (explaining that the universal-

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526 VERIZON COMMUNICATIONS INC. v. FCC
Opinion of the Court
service model may not be “appropriate [for] determining . . .
prices for unbundled network elements”). We do not know
how much higher the efficient replacement figure should be,
but we can reasonably assume that $180 billion is too low.
On the other side of the comparison, the “balance sheet”
number is patently misstated. As explained above, any
rates under the traditional public-utility model would be cal-
culated on a rate base (whether fair value or cost of service)
subject to deductions for accrued depreciation. See Phillips
310–315. The net plant investment after depreciation is
not $342 billion but $166 billion, FCC, Statistics of Commu-
nications Common Carriers, at 51 (table 2.9, line no. 50), an
amount less than the TELRIC figure the incumbents would
like us to assume. And even after we increase the $166 bil-
lion by the amount of net current liabilities ($22 billion) on
the balance sheet, ibid. (line no. 64 minus line no. 13), as a
rough (and generous) estimate of the working-capital allow-
ance under cost of service, the rate base would then be $188
billion, still a far cry from the $342 billion the incumbents
tout, and less than 5 percent above the incumbents’ $180 bil-
lion universal-service TELRIC figure. What the best num-
bers may be we are in no position to say: the point is only
that the numbers being thrown out by the incumbents are
no evidence that TELRIC lease rates would be confiscatory,
sight unseen.
The incumbent carriers’ second try at nonrate constitu-
tional litigation focuses on reliance interests allegedly jeop-
ardized by an intentional switch in ratesetting methodolo-
gies. They rely on Duquesne, where we held as usual that
a ratesetting methodology would normally be judged only by
the “overall impact of the rate orders,” 36 but went further
36 The Court upheld a Pennsylvania statute barring rate recovery of
capital prudently invested in canceled power plants because the “overall
impact of the rate orders,” which allowed returns on common equity of
16 percent and overall returns of 11 to 12 percent, was not “constitution-
ally objectionable.” 488 U. S., at 312; see also id., at 314 (“ ‘It is not

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in dicta. We remarked that “a State’s decision to arbitrarily
switch back and forth between methodologies in a way which
required investors to bear the risk of bad investments at
some times while denying them the benefit of good invest-
ments at others would raise serious constitutional ques-
tions.” 488 U. S., at 315.37 In other words, there may be
a taking challenge distinct from a plain-vanilla objection to
arbitrary or capricious agency action 38 if a ratemaking body
were to make opportunistic changes in ratesetting method-
ologies just to minimize return on capital investment in a
utility enterprise.
In Duquesne itself, there was no need to decide whether
there might be an exception to the rate-order requirement
for a claim of taking by rates, and there is no reason here to
decide whether the policy of constitutional avoidance should
be invoked in order to anticipate a rate-order taking claim.
The reason is the same in each case: the incumbent carriers
here are just like the electric utilities in Duquesne in failing
to present any evidence that the decision to adopt TELRIC
theory, but the impact of the rate order which counts’ ”) (quoting FPC v.
Hope Natural Gas Co., 320 U. S. 591, 602 (1944)). The utilities in Du-
quesne, like the incumbents here, made “[n]o argument . . . that . . . reduced
rates jeopardize the financial integrity of the companies, either by leaving
them insufficient operating capital or by impeding their ability to raise
future capital.” 488 U. S., at 312. Nor did they show that allowed rates
were “inadequate to compensate current equity holders for the risk as-
sociated with their investments under a modified prudent investment
scheme.” Ibid.
37 Justice Scalia, joined by Justice White and Justice O’Connor,
concurred, and noted that “all prudently incurred investment may well
have to be counted” to determine “whether the government’s action is
confiscatory.” Id., at 317.
38 The incumbents make the additional argument that it was arbitrary
or capricious for the FCC to reject historical costs, Brief for Petitioners
in No. 00–511, at 44–49, but this is simply a restatement of the argument
that the FCC was unreasonable in interpreting § 252(d)(1) to foreclose the
use of historical cost in ratesetting, which we have already addressed, see
Part III–B–2, supra.

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was arbitrary, opportunistic, or undertaken with a confisca-
tory purpose. What we do know is very much to the con-
trary. First of all, there was no “switch” of methodologies,
since the wholesale market for leasing network elements is
something brand new under the 1996 Act. There was no
replacement of any predecessor methods, much less an op-
portunistic switch “back and forth.” And to the extent that
the incumbents argue that there was at least an expectation
that some historically anchored cost-of-service method would
set wholesale lease rates, no such promise was ever made.
First Report and Order ¶ 706 (“[C]ontrary to assertions by
some [incumbents], regulation does not and should not guar-
antee full recovery of their embedded costs. Such a guaran-
tee would exceed the assurances that [the FCC] or the states
have provided in the past”). Cf. Duquesne, supra, at 315.
Any investor paying attention had to realize that he could
not rely indefinitely on traditional ratemaking methods but
would simply have to rely on the constitutional bar against
confiscatory rates.39
IV
A
The effort by the Government and the competing carriers
to overturn the Eighth Circuit’s invalidation of the additional
39 In fact, the FCC’s order is more hospitable to early taking claims than
any court would be under Duquesne: “Incumbent LECs may seek relief
from the Commission’s pricing methodology, if they provide specific in-
formation to show that the pricing methodology, as applied to them, will
result in confiscatory rates.” First Report and Order ¶ 739. The FCC,
in other words, is willing to consider a challenge to TELRIC in advance
of a rate order, but any challenger needs to go beyond general criticism
of a method’s tendency, and to show with “specific information” that a
confiscatory rate is bound to result. Additionally, as the FCC has ac-
knowledged, the smallest, rural incumbent local-exchange carriers most
likely to suffer immediately from the imposition of unduly low rates
are expressly exempt from the TELRIC pricing rules under 47 U. S. C.
§ 252(f)(1), see First Report and Order ¶ 706, and other rural incumbents
may obtain exemptions from the rules by applying to their state commis-
sions under § 252(f)(2).

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combination rules, 47 CFR §§ 51.315(c)–(f) (1997), draws the
incumbents’ threshold objection that the challenge is barred
by waiver, since the 1999 petition to review the 1997 invali-
dation of Rule 315(b) did not extend to the Eighth Circuit’s
simultaneous invalidation of the four companion rules, Rules
315(c)–(f), 120 F. 3d, at 813, 819, n. 39.40 The incumbents
must, of course, acknowledge that the Court of Appeals sua
sponte invited briefing on the status of Rules 315(c)–(f) 41 on
remand after this Court’s reinstatement of Rule 315(b), Iowa
Utilities Bd., 525 U. S., at 395, and specifically struck them
down again, albeit on its 1997 rationale, 219 F. 3d, at 758–759.
But the incumbent carriers argue that the Eighth Circuit
exceeded the scope of this Court’s mandate when it revisited
the unchallenged portion of its earlier holding, so that this
Court should decline to reach the validity of Rules 315(c)–(f)
today. To do so, they say, would encourage the sort of stra-
tegic, piecemeal litigation disapproved in Communist Party
of United States v. Subversive Activities Control Bd., 367
U. S. 1, 30–31 (1961):
“The demands not only of orderly procedure but of due
procedure as the means of achieving justice according to
law require that when a case is brought here for review
of administrative action, all the rulings of the agency
upon which the party seeks reversal, and which are then
available to him, be presented. Otherwise we would be
promoting the ‘sporting theory’ of justice, at the poten-
tial cost of substantial expenditures of agency time. To
allow counsel to withhold in this Court and save for a
later stage procedural error would tend to foist upon
40 AT&T did not raise the issue in the relevant petition for certiorari
as it claims. See Pet. for Cert. in AT&T Corp. v. Iowa Utilities Bd., O. T.
1998, No. 97–826, pp. 9–10, 13.
41 See Order in Iowa Utilities Bd. v. FCC, No. 96–3321, etc. (CA8, June
10, 1999), pp. 2–3 (“The briefs should also address whether or not, in light
of the Supreme Court’s decision, this court should take any further action
with respect to . . . § 315(c)–(f)”).

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the Court constitutional decisions which could have been
avoided had those errors been invoked earlier.”
We do not think Communist Party blocks our consider-
ation of Rules 315(c)–(f). The issue there was raised by the
petitioner’s failure on an earlier trip to this Court to pursue
a procedural objection to agency action. Litigation of the
procedural point would not only have obviated the Court’s
need to review the constitutionality of an Act of Congress
when the case got here, but could have saved five years of
litigation during which time “the Board and the Court of
Appeals [had] each twice more reconsidered [the] steadily
growing record . . . .” Id., at 31–32, n. 8. After all that
time, petitioner sought review of the procedural point.
Nothing like that can be said about these cases. Address-
ing the issue now would not “make waste” of years of efforts
by the FCC or the Court of Appeals, id., at 32, n. 8, would
not threaten to leave a constitutional ruling pointless, and
would direct the Court’s attention not to an isolated, “long-
stale” procedural error by the agency, ibid., but to the in-
validation of FCC rules meant to have general and continu-
ing applicability. There is no indication of litigation tactics
behind the failure last time to appeal on these rules, which
were reexamined on remand at the behest of the court, not
the Government or the competing carriers.
Any issue “pressed or passed upon below” by a federal
court, United States v. Williams, 504 U. S. 36, 41 (1992) (in-
ternal quotation marks omitted), is subject to this Court’s
broad discretion over the questions it chooses to take on cer-
tiorari, and there are good reasons to look at Rules 315(c)–(f).
The Court of Appeals passed on a significant issue, and one
placed in a state of flux, see Virginia Bankshares, Inc. v.
Sandberg, 501 U. S. 1083, 1099, n. 8 (1991) (citations omitted),
by the split between these cases and US West Communica-
tions v. MFS Intelenet, Inc., 193 F. 3d 1112, 1121 (CA9 1999),
(affirming identical state-commission rules), cert. denied, 530
U. S. 1284 (2000). We accordingly rejected the incumbents’

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claim of waiver when they raised it in opposition to the peti-
tion for certiorari, and we reject it again today. See Stevens
v. Department of Treasury, 500 U. S. 1, 8 (1991).
B
The Eighth Circuit found the four additional combination
rules at odds with the plain language of the final sentence of
47 U. S. C. § 251(c)(3), which we quote more fully:
“[E]ach incumbent local exchange carrier has . . .
. . . . .
“[t]he duty to provide, to any requesting telecommuni-
cations carrier for the provision of a telecommunications
service, nondiscriminatory access to network elements
on an unbundled basis at any technically feasible point
on rates, terms, and conditions that are just, reasonable,
and nondiscriminatory . . . . An incumbent local ex-
change carrier shall provide such unbundled network
elements in a manner that allows requesting carriers
to combine such elements in order to provide such tele-
communications service.”
“Bundling” and “combination” are related but distinct con-
cepts. Bundling is about lease pricing. To provide a net-
work element “on an unbundled basis” is to lease the ele-
ment, however described, to a requesting carrier at a stated
price specific to that element. Iowa Utilities Bd., supra,
at 394. The FCC’s regulations identify in advance a certain
number of elements for separate pricing, 47 CFR § 51.319
(1997), but the regulations do not limit the elements subject
to specific rates. A separately priced element need not be
the simplest possible configuration of equipment or function,
and a predesignated unbundled element might actually com-
prise items that could be considered separate elements them-
selves. For example, “if the states require incumbent LECs
to provision subloop elements [which together constitute a
local loop], incumbent LECs must still provision a local loop

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as a single, combined element when so requested, because
we identify local loops as a single element in this proceed-
ing.” First Report and Order ¶ 295. The “combination”
provided for in Rules 315(b)–(f), on the other hand, refers
to a mechanical connection of physical elements within an
incumbent’s network, or the connection of a competitive car-
rier’s element with the incumbent’s network “in a manner
that would allow a requesting carrier to offer the telecommu-
nications service.” Id., ¶ 294, n. 620.
The additional combination rules are best understood as
meant to ensure that the statutory duty to provide unbun-
dled elements gets a practical result. A separate rate for
an unbundled element is not much good if an incumbent re-
fuses to lease the element except in combination with others
that competing carriers have no need of; or if the incum-
bents refuse to allow the leased elements to be combined
with a competitor’s own equipment. And this is just what
was happening before the FCC devised its combination
rules. Incumbents, according to the FCC’s findings, were
refusing to give competitors’ technicians access to their
physical plants to make necessary connections. In re Im-
plementation of the Local Competition Provisions of the
Telecommunications Act of 1996, 15 FCC Rcd. 3696, 3910,
¶ 482 (1999) (Third Report and Order), petitions for review
pending sub nom. United States Telecom Assn. v. FCC,
Nos. 00–1015, etc. (CADC).
The challenged additional combination rules, issued under
§ 251(c)(3), include two that are substantive and two that are
procedural, the latter having no independent significance
here. Rule 315(c) requires an incumbent to “perform the
functions necessary to combine unbundled network ele-
ments in any manner, even if those elements are not ordi-
narily combined” in the incumbent’s own network, so long
as the combination is “[t]echnically feasible” and “[w]ould
not impair the ability of other carriers to obtain access to
unbundled network elements or to interconnect” with the

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533 Cite as: 535 U. S. 467 (2002)
Opinion of the Court
incumbent’s network. The companion Rule 315(d) likewise
requires the incumbent to do the combining between the
network elements it leases and a requesting carrier’s own
elements, so long as technically feasible.42
The rules are challenged alternatively as inconsistent with
statutory plain language and as unreasonable interpreta-
tions. The plain language in question is the sentence that
“[a]n incumbent local exchange carrier shall provide such un-
bundled network elements in a manner that allows request-
ing carriers to combine such elements in order to provide
such telecommunications service.” 47 U. S. C. § 251(c)(3).
The Eighth Circuit read this as unambiguously excusing in-
cumbents from any obligation to combine provided elements,
219 F. 3d, at 759. The ruling has a familiar ring, for this is
the same reason that the Court of Appeals invalidated these
rules in 1997 along with Rule 315(b), as being inconsistent
with a plain limit on incumbents’ obligation under § 251(c)(3)
to provide elements “on an unbundled basis.” 120 F. 3d,
at 813.
But the language is not that plain. Of course, it is true
that the statute would not be violated literally by an incum-
bent that provided elements so that a requesting carrier
could combine them, and thereafter sat on its hands while
any combining was done. But whether it is plain that the
incumbents have a right to sit is a question of context as
much as grammar. If Congress had treated incumbents and
entrants as equals, it probably would be plain enough that
the incumbents’ obligations stopped at furnishing an element
that could be combined. The Act, however, proceeds on the
understanding that incumbent monopolists and contending
competitors are unequal, cf. § 251(c) (“Additional obligations
of incumbent local exchange carriers”), and within the actual
statutory confines it is not self-evident that in obligating
42 Under Rules 315(e)–(f), an incumbent that denies a requested combi-
nation has the burden to prove technical infeasibility or to show how the
combination would impede others’ access.

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534 VERIZON COMMUNICATIONS INC. v. FCC
Opinion of the Court
incumbents to furnish, Congress negated a duty to combine
that is not inconsistent with the obligation to furnish, but
not expressly mentioned. Thus, it takes a stretch to get
from permissive statutory silence to a statutory right on the
part of the incumbents to refuse to combine for a requesting
carrier, say, that is unable to make the combination, First
Report and Order ¶ 294, or may even be unaware that it
needs to combine certain elements to provide a telecom-
munications service. Id., ¶ 293. And these are the only in-
stances in which the additional combination rules obligate
the incumbents according to the FCC’s clarification in the
First Report and Order.
The conclusion that the language is open is certainly in
harmony with, if not required by, our holding in Iowa Utili-
ties Bd., dealing with Rule 315(b). In reinstating that rule,
we rejected the argument that furnishing elements “on an
unbundled basis,” § 251(c)(3), must mean “physically sepa-
rated,” 525 U. S., at 394, and expressly noted that “§ 251(c)(3)
is ambiguous on whether leased network elements may or
must be separated,” id., at 395. We relied on that ambiguity
in holding that an incumbent has no statutory right to sepa-
rate elements when a competitor asks to lease them in the
combined form employed by the incumbent in its own net-
work. Ibid. That holding would make a very odd partner
with a ruling that an ambiguous § 251(c)(3) plainly empowers
incumbent carriers to refuse to combine elements even when
requesting carriers cannot. We accordingly read the lan-
guage of § 251(c)(3) as leaving open who should do the work
of combination, and under Chevron U. S. A. Inc. v. Natural
Resources Defense Council, Inc., 467 U. S. 837 (1984), that
leaves the FCC’s rules intact unless the incumbents can
show them to be unreasonable.
For the decision whether Rules 315(c)–(f) survive Chevron
step two, Iowa Utilities Bd. is, to be sure, less immedi-
ate help, since in that case we found Rule 315(b) reasonable
because it prevented incumbents from dismantling exist-

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535 Cite as: 535 U. S. 467 (2002)
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ing combinations to sabotage competitors, 525 U. S., at 395,
whereas here we deal not with splitting up but with joining
together. We think, nonetheless, that the additional com-
bination rules reflect a reasonable reading of the statute,
meant to remove practical barriers to competitive entry into
local-exchange markets while avoiding serious interference
with incumbent network operations.
At the outset, it is well to repeat that the duties imposed
under the rules are subject to restrictions limiting the bur-
dens placed on the incumbents. An obligation on the part
of an incumbent to combine elements for an entrant under
Rules 315(c) and (d) only arises when the entrant is unable
to do the job itself. First Report and Order ¶ 294 (“If the
carrier is unable to combine the elements, the incumbent
must do so”). When an incumbent does have an obligation,
the rules specify a duty to “perform the functions necessary
to combine,” not necessarily to complete the actual combi-
nation. 47 CFR §§ 51.315(c)–(d) (1997). And the entrant
must pay “a reasonable cost-based fee” for whatever the
incumbent does. Brief for Petitioner Federal Parties in
Nos. 00–587, etc., p. 34. See also id., at 10, 34, n. 14.
The force of the objections is limited further by the FCC’s
implementation in the rules of the statutory conditions that
the incumbents’ duty arises only if the requested combina-
tion does not discriminate against other carriers by impeding
their access, and only if the requested combination is “techni-
cally feasible,” § 251(c)(3). As to the latter restriction, the
Commission “decline[d] to adopt the view proffered by some
parties that incumbents must combine network elements in
any technically feasible manner requested.” First Report
and Order ¶ 296. The concern was that such a rule “could
potentially affect the reliability and security of the incum-
bent’s network, and the ability of other carriers to obtain
interconnection, or request and use unbundled elements.”
Ibid.

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536 VERIZON COMMUNICATIONS INC. v. FCC
Opinion of the Court
Thus, the incumbents are wrong to claim that the re-
striction to “technical feasibility” places only minimal limits
on the duty to combine, since the First Report and Order
makes it clear that what is “technically feasible” does not
mean merely what is “economically reasonable,” id., ¶ 199, or
what is simply practical or possible in an engineering sense,
see id., ¶¶ 196–198. The limitation is meant to preserve
“network reliability and security,” id., ¶ 296, n. 622, and a
combination is not technically feasible if it impedes an in-
cumbent carrier’s ability “to retain responsibility for the
management, control, and performance of its own network,”
id., ¶ 203.
This demanding sense of “technical feasibility,” as a con-
dition protecting the incumbent’s ability to control the per-
formance of its own network, is in accord with what we said
in Iowa Utilities Bd. There, for example, we reinstated the
Commission’s “pick and choose” rule 43 in part because the
duty to provide network elements on matching terms to all
comers did not arise when it was “not technically feasible,”
§ 51.809(b)(2). 525 U. S., at 396. If “technically feasible”
meant what is merely possible, it would have been no limita-
tion at all.
The two substantive rules each have additional features
that are consistent with the purposes of § 251(c)(3). Rule
315(c), to the extent that it raises a duty to combine what
is “ordinarily combined,” neatly complements the facially
similar Rule 315(b), upheld in Iowa Utilities Bd., id., at 395,
forbidding incumbents to separate currently combined net-
work elements when the entrant requests them in a com-
bined form. If the latter were the only rule, an incumbent
43 “An incumbent LEC shall make available without unreasonable delay
to any requesting telecommunications carrier any individual inter-
connection, service, or network element arrangement contained in any
agreement to which it is a party that is approved by a state commission
pursuant to section 252 of the Act, upon the same rates, terms, and condi-
tions as those provided in the agreement.” 47 CFR § 51.809(a) (1997).

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might well be within its rights to insist, for example, on pro-
viding a loop and a switch in a combined form when a naive
entrant asked just for them, while refusing later to combine
them with a network interface device, which is also ordi-
narily combined with the loop and the switch, and which
is necessary to set up a telecommunications link. But
under Rule 315(c), when the entrant later requires the
element it missed the first time, the incumbent’s obligation
is to “perform the functions necessary,” 47 CFR § 51.315(c)
(1997), for a combination of what the entrant cannot com-
bine alone, First Report and Order ¶ 294, and would not
have needed to combine if it had known enough to request
the elements together in a combined form in the first place.
Cf. id., ¶ 297 (“[I]ncumbent[s] must work with new entrants
to identify the elements the new entrants will need to
offer a particular service in the manner the new entrants
intend”).
Of course, it is not this aspect of Rule 315(c), requiring
the combination of what is ordinarily combined, that draws
the incumbents’ (or Justice Breyer’s, see post, at 563)
principal objection; they focus their attack, rather, on the
additional requirement of Rule 315(c), that incumbents com-
bine unbundled network elements “even if those elements
are not ordinarily combined in the incumbent[’s] network.”
47 CFR § 51.315(c) (1997). To build upon our previous ex-
ample, this would seemingly require an incumbent to com-
bine the loop, switch, and interface (ordinarily combined in
its network) with a second loop and network interface (pro-
vided by the incumbent as a separate unbundled element),
so that the competitive carrier could charge for a second-line
connection, as for a fax or modem. See Brief for Petitioners
Worldcom, Inc., et al. in No. 00–555, at 48 (providing the
example).
But this provision of Rule 315(c) is justified by the statu-
tory requirement of “nondiscriminatory access.” § 251(c)(3).
As we have said, the FCC has interpreted the rule as obli-

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538 VERIZON COMMUNICATIONS INC. v. FCC
Opinion of the Court
gating the incumbent to combine “[i]f the carrier is unable
to combine the elements.” First Report and Order ¶ 294.
There is no dispute that the incumbent could make the com-
bination more efficiently than the entrant; nor is it contested
that the incumbent would provide the combination itself
if a customer wanted it or the combination otherwise served
a business purpose. See Third Report and Order ¶ 481.
It hardly seems unreasonable, then, to require the incumbent
to make the combination, for which it will be entitled to a
reasonable fee; otherwise, an entrant would not enjoy true
“nondiscriminatory access” notwithstanding the bare pro-
vision on an unbundled basis of the network elements it
needs to provide a service.
As to Rule 315(d), it is hard to see how this rule is any
less reasonable than § 251(c)(2), which imposes a statutory
duty to interconnect. The rule simply requires the in-
cumbent to perform functions necessary to combine the
unbundled elements it provides with elements owned by
the requesting carrier “in any technically feasible manner.”
Essentially, it appears to be nothing more than an element-
to-element version of the incumbents’ statutory duty “to pro-
vide, for the facilities and equipment of any requesting . . .
carrier, interconnection with the local exchange carrier’s
network,” in § 251(c)(2).
In sum, what we have are rules that say an incumbent
shall, for payment, “perform the functions necessary,” 47
CFR §§ 51.315(c) and (d) (1997), to combine network elements
to put a competing carrier on an equal footing with the in-
cumbent when the requesting carrier is unable to combine,
First Report and Order ¶ 294, when it would not place the
incumbent at a disadvantage in operating its own net-
work, and when it would not place other competing carriers
at a competitive disadvantage, 47 CFR § 51.315(c)(2) (1997).
This duty is consistent with the Act’s goals of competition
and nondiscrimination, and imposing it is a sensible way to
reach the result the statute requires.

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539 Cite as: 535 U. S. 467 (2002)
Opinion of Breyer, J.
* * *
The 1996 Act sought to bring competition to local-
exchange markets, in part by requiring incumbent local-
exchange carriers to lease elements of their networks at
rates that would attract new entrants when it would be more
efficient to lease than to build or resell. Whether the FCC
picked the best way to set these rates is the stuff of debate
for economists and regulators versed in the technology of
telecommunications and microeconomic pricing theory. The
job of judges is to ask whether the Commission made choices
reasonably within the pale of statutory possibility in de-
ciding what and how items must be leased and the way to set
rates for leasing them. The FCC’s pricing and additional
combination rules survive that scrutiny.
The judgment of the Court of Appeals is reversed in part
and affirmed in part, and the cases are remanded for further
proceedings consistent with this opinion.
It is so ordered.
Justice O’Connor took no part in the consideration or
decision of these cases.
Justice Breyer, with whom Justice Scalia joins as to
Part VI, concurring in part and dissenting in part.
I agree with the majority that the Telecommunications Act
of 1996 (Act or Telecommunications Act), 47 U. S. C. § 251
et seq. (1994 ed. and Supp. V), does not require a historical
cost pricing system. I also agree that, at the present time,
no taking of the incumbent firms’ property in violation of
the Fifth Amendment has occurred. I disagree, however,
with the Court’s conclusion that the specific pricing and un-
bundling rules at issue here are authorized by the Act.
I
The primary goal of the Telecommunications Act is to
“promote competition and reduce regulation” in both local

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540 VERIZON COMMUNICATIONS INC. v. FCC
Opinion of Breyer, J.
and long-distance telecommunications markets. Preamble,
110 Stat. 56; see also H. R. Conf. Rep. No. 104–458, p. 1
(1996). As part of that effort, the Act requires incumbent
local telecommunications firms to make certain “elements”
of their local systems available to new competitors seeking
to enter those local markets. 47 U. S. C. § 251(c)(3) (1994 ed.,
Supp. V). If the incumbents and competitors cannot agree
on the price that an incumbent can charge a new entrant,
local regulators will determine the price. § 252. The regu-
lated price will depend upon the element’s “cost.” § 252(d)
(1)(A). In AT&T Corp. v. Iowa Utilities Bd., 525 U. S. 366
(1999), this Court held that the Act authorizes the Federal
Communications Commission (FCC or Commission) to set
rules for determining those prices.
These cases require the Court to review the Commission’s
rules. Those rules create a “start-from-scratch” version of
what the Commission calls a “Total Element Long-Run In-
cremental Cost” system (TELRIC). See Kahn, Tardiff, &
Weisman, The Telecommunications Act at three years: an
economic evaluation of its implementation by the Federal
Communications Commission, 11 Info. Econ. & Policy 319,
326 (1999) (hereinafter Kahn) (referring to the FCC’s system
as “TELRIC-Blank Slate”). In essence, the Commission re-
quires local regulators to determine the cost of supplying a
particular incumbent network “element” to a new entrant,
not by looking at what it has cost that incumbent to sup-
ply the element in the past, nor by looking at what it will
cost that incumbent to supply that element in the future.
Rather, the regulator must look to what it would cost a
hypothetical perfectly efficient firm to supply that element
in the future, assuming that the hypothetical firm were to
build essentially from scratch a new, perfectly efficient com-
munications network. The only concession to the incum-
bent’s actual network is the presumption that presently
existing wire centers—which hold the switching equipment
for a local area—will remain in their current locations.

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541 Cite as: 535 U. S. 467 (2002)
Opinion of Breyer, J.
See In re Implementation of Local Competition Provisions
in the Telecommunications Act of 1996, 11 FCC Rcd. 15499,
15848–15849, ¶ 685 (1996) (hereinafter Order) (describing
TELRIC as “based on costs that assume that wire centers
will be placed at the incumbent LEC’s current wire center
locations, but that the reconstructed local network will em-
ploy the most efficient technology for reasonably foreseeable
capacity requirements”).
An example will help explain the system as I under-
stand it. Imagine an incumbent local telephone company’s
major switching center, say, in downtown Chicago, from
which cables and wires run through conduits or along poles
to subsidiary switching equipment, other electronic equip-
ment, and eventually to end-user equipment, such as tele-
phone handsets, computer modems, or fax machines located
in office buildings or private residences. A new competitor,
whom the law entitles to use an “element” of the incumbent
firm’s system, asks for use of such an “element,” say, a single
five-block portion of this system, thereby obtaining access
to 20 downtown office buildings. Under the Commission’s
TELRIC, the incumbent’s “cost” (upon which “rates” must
be based) equals not the real resources that the Chicago
incumbent must spend to provide the five-block “element”
demanded, but the resources that a hypothetical perfectly
efficient new supplier would spend were that supplier re-
building the entire downtown Chicago system, other than
the local wire center, from scratch. This latter figure, of
course, might be very different from any incumbent’s actual
costs.
As a reviewing Court, we must determine, among other
things, whether the Commission has “ ‘abuse[d]’ ” its statu-
torily delegated “ ‘discretion’ ” to create implementing rules.
Motor Vehicle Mfrs. Assn. of United States, Inc. v. State
Farm Mut. Automobile Ins. Co., 463 U. S. 29, 41 (1983) (quot-
ing Administrative Procedure Act, 5 U. S. C. § 706(2)(A)). In
doing so, we must assume that Congress intended to grant

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542 VERIZON COMMUNICATIONS INC. v. FCC
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the Commission broad legal leeway in respect to the sub-
stantive content of the rules, Citizens to Preserve Overton
Park, Inc. v. Volpe, 401 U. S. 402, 416 (1971); FPC v. Hope
Natural Gas Co., 320 U. S. 591, 602 (1944), particularly
since the subject matter is a highly technical one, namely,
ratemaking, where the agency possesses expert knowledge.
Chevron U. S. A. Inc. v. Natural Resources Defense Council,
Inc., 467 U. S. 837, 843–844 (1984).
Nonetheless, that leeway is not unlimited. It is bounded,
for example, by the scope of the statute that grants authority
and by the need for the agency to show a “rational connec-
tion” between the regulations and the statute’s purposes.
State Farm, 463 U. S., at 56. We must determine whether,
despite the leeway given experts on technical subject matter,
agency regulations exceed these legal limits. See id., at 43;
Overton Park, supra, at 416; Administrative Procedure Act,
5 U. S. C. § 706(2)(A) (requiring agency action to be set aside
if “arbitrary, capricious, an abuse of discretion, or otherwise
not in accordance with law”). And, reluctantly, I have come
to the conclusion that they do. After considering the in-
cumbents’ objections and the Commission’s responses, I can-
not find that “rational connection” between statutory pur-
pose and implementing regulation that the law demands.
State Farm, supra, at 56.
II
Because the critical legal problem concerns the relation
of the Commission’s regulations to the statute’s purpose,
I must ask at the outset, what is that purpose? The rele-
vant statutory provision says only that the agency shall set
“rate[s]” (for “elements”) “based on . . . cost.” 47 U. S. C.
§ 252(d)(1). At first blush the word “cost” calls to mind
traditional cost-based ratesetting. See Natural Gas Act, 15
U. S. C. § 717c; Natural Gas Act of 1938, §§ 4a, 5, 52 Stat.
824; Interstate Commerce Act, 49 U. S. C. § 10701 (1994 ed.,
Supp. V); Federal Aviation Act of 1958, 49 U. S. C. § 1302(c)
(1976 ed., Supp. II) (repealed 1980); see also ante, at 478

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Opinion of Breyer, J.
(discussing traditional ratesetting); J. Bonbright, A. Daniel-
sen, & D. Kamerschen, Principles of Public Utility Rates
109–110, 388 (2d ed. 1988) (hereinafter Bonbright); In re Im-
plementation of Sections of the Cable Television Consumer
Protection and Competition Act of 1992: Rate Regulation,
9 FCC Rcd. 4527, 4555, ¶ 55 (1994) (Commission rules refer-
ring to “[o]riginal cost” as traditional basis “for public util-
ity valuation”).
An agency engaged in traditional ratemaking will seek to
protect consumers by mandating low prices as the end result.
In doing so, the agency will sometimes try to mimic the
prices that it believes (hypothetically) the regulated firm
(often a legal monopoly) would have set had it been an un-
regulated firm in a competitively structured industry. See
ante, at 486; Bonbright 89 (“[M]any economists have declared
that . . . the prices that would result without regulation but
under pure or perfect competition would be the ‘ideal’
prices”); 1 A. Kahn, Economics of Regulation: Principles and
Institutions 63 (1988) (hereinafter Economics of Regulation)
(“The traditional legal criteria of proper public utility rates
have always borne a strong resemblance to the criteria of
the competitive market in long-run equilibrium”). And the
Commission’s regulations are at least arguably consistent
with an agency effort to find prices that replicate the end
results of theoretically perfect competition. See Order
¶¶ 679, 738.
But that regulatory objective—low, competition-
mimicking prices—is not the objective of the relevant statu-
tory provision here. The Telecommunications Act is not a
ratemaking statute seeking better regulation. It is a de-
regulatory statute seeking competition. It assumes that,
given modern technology, local telecommunications markets
may now prove large enough for several firms to compete in
the provision of some services—but not necessarily all serv-
ices—without serious economic waste. It finds the competi-
tive process an indirect but more effective way to bring

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544 VERIZON COMMUNICATIONS INC. v. FCC
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about the common objectives of competition and regulation
alike, namely, low prices, better products, and more efficient
production methods. But it authorizes the Commission to
promulgate rules that will help achieve that procedural
goal—the substitution of competition for regulation in local
markets—where that transformation is economically fea-
sible. See ante, at 539 (accepting this rationale). The Act
does not authorize the Commission to promulgate rules that
would hinder the transition from a regulated to a com-
petitive marketplace—whether or not those rules directly
mandate lower “element” prices along the way.
Five considerations, taken together, convince me that
the description of the statutory goal I have just given is an
accurate one. First, the Act itself says that its objective
is to substitute competition for regulation. Preamble, 110
Stat. 56 (stating that the goal of the Act is to “promote com-
petition and reduce regulation” in both local and long-
distance telecommunications markets); see also H. R. Conf.
Rep. No. 104–458, at 1; ante, at 489.
Second, the Act’s history suggests the Congress would
have thought that goal a reasonable one. The 20th century’s
history of telecommunications markets is primarily one of
regulation. For decades experts justified regulation on the
ground that telecommunications providers were “natural
monopolists,” i. e., telecommunications markets would not
support more than one firm of efficient size. See ante, at
475–476. But beginning in the 1970’s, technological develop-
ments led to a change of expert opinion by undermining
the “natural monopoly” rationale. Long-distance telecom-
munications markets seemed newly capable of supporting
several competing firms without significant economic waste.
See R. Vietor, Contrived Competition: Regulation and De-
regulation in America 185–190 (1994). And opinion began
to change similarly in respect to local markets. In the case
of local markets, however, the change was marked by hesita-
tion and lingering uncertainty. See P. Huber, M. Kellogg, &

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Opinion of Breyer, J.
J. Thorne, Federal Telecommunications Law 53, 86–87 (2d ed.
1999) (hereinafter Huber); P. Huber, M. Kellogg, & J. Thorne,
The Geodesic Network II: 1993 Report on Competition in
the Telephone Industry 2.1–2.5 (1992). That is because local
telecommunications service had long demanded expensive
fixed investment, for example, digging up streets to lay ca-
bles or stringing wires on overhead poles. See ante, at 489–
491. And whether, or the extent to which, a new competitor
could replicate, or avoid, that kind of investment without sig-
nificantly wasting resources remained unclear. See Huber
34, 206. Thus, at the time Congress wrote the new Act,
technological development seemed to permit nonwasteful
competition in respect to some aspects of local service;
but in respect to other aspects an incumbent local telecom-
munications provider might continue to possess “natural
monopoly” advantages. Id., at 206–207. And these circum-
stances made it reasonable for Congress to try to secure local
competition insofar as that competition would prove eco-
nomically feasible, i. e., where competition would not prove
seriously wasteful. See Order ¶ 1. See also 47 U. S. C.
§§ 271(c)(1)(A), 271(c)(1)(B) (recognizing that some local mar-
kets will not support more than one firm).
Third, the Act’s structure and language indicate a con-
gressional effort to secure that very end. The Act dis-
mantles artificial legal barriers to new entry in local mar-
kets, thereby permitting new firms to enter if they wish.
§ 253(a); see ante, at 491, and n. 12. But the Act recognizes
that simple permission may not prove sufficient—perhaps
because the incumbent will retain a “natural monopoly” form
of control over certain necessary elements of service. It
consequently goes on to promote new entry in three ways.
See ante, at 491–492. First, it requires incumbents to “in-
terconnect” with new entrants (at a price determined by the
regulations before us), thereby allowing a new entrant’s
small set of subscribers to connect with the incumbent firm’s
likely larger customer base. § 251(c)(2). Second, it requires

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incumbents to sell retail services to new entrants at whole-
sale rates, thereby allowing newly entering firms automati-
cally to compete in retailing if they so desire. § 251(c)(4).
Third, it requires incumbents to provide new entrants “ac-
cess to network elements,” say, telephone lines connecting
homes or offices with switching centers, “on an unbundled
basis.” § 251(c)(3). This third requirement permits a new
entrant to compete selectively without replicating (or substi-
tuting) all of the elements the incumbent uses to offer the
service in question.
Suppose, for example, the incumbent’s control of certain
existing cables, lines, or switching equipment would put
the new entrant at an economic disadvantage because dupli-
cation of those “elements” would prove unnecessarily ex-
pensive. The new Act does not require the new entrant
and incumbent to compete in respect to those elements,
say, through wasteful duplication. Rather, the Act permits
the new entrant to offer, and to compete with respect to, a
related service by obtaining “access” to (and therefore using)
those “elements” of the incumbent’s network, while find-
ing on its own other elements necessary to the service.
It is as if a railroad regulator, anxious to promote railroad
competition between City A and City B but aware that it
would prove wasteful to duplicate a certain railroad bridge
across the Mississippi River, ordered the bridge’s owner
to share the bridge with new competitors. The sharing
would avoid wasteful duplication of the hard-to-duplicate re-
source—namely, the bridge. But at the same time it would
facilitate competition in the remaining aspects of the A-to-B
railroad service. That, I assume, is why the Act says that
the “elements” that must be shared are those for which ac-
cess is “necessary” and in respect to which “failure to pro-
vide access” would “impair” the ability of the new entrant
“to provide the services that it seeks to offer.” § 251(d)(2).
See Iowa Utilities Bd., 525 U. S., at 392 (Commission must
give “substance to the ‘necessary’ and ‘impair’ require-

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ments”); cf. id., at 416–417 (Breyer, J., concurring in part
and dissenting in part) (stating that the “necessary” and “im-
pair” provision’s object is to require access to, and thereby
force sharing of, those elements of an incumbent’s system
that would prove, to a significant degree, economically
wasteful to duplicate).
To put the matter more concretely, imagine that a commu-
nications firm—a potential new entrant—wishes to sell voice,
data, text, pictures, entertainment, or other communications
services, perhaps in competition with the incumbent. That
firm must decide how its service will reach a customer inside
a house or office. Should the firm (1) run its own new cable
into the house? (2) run wires through an already-existing
electricity conduit? (3) communicate without wires, say, by
wireless or one-way or two-way satellite? (4) or use the
incumbent’s pair of twisted copper telephone service wires
already in place? If the potential new entrant claims that
all but the last of these possibilities are impractical or
far too expensive—that using existing telephone wires is far
cheaper (in terms of real resources expended) than the alter-
natives—then the new entrant is claiming that the incum-
bent’s wires are a kind of “bridge” to which it must have
access. And it may ask the regulator to make its new entry
feasible by requiring the incumbent to permit it to use that
“element” at a reasonable price.
Fourth, the Commission has described the Act’s goals as
including promotion of nonwasteful competition. The pre-
amble to the Commission’s price regulations describes
their statutorily based aim as “giv[ing] appropriate signals
to producers and consumers and ensur[ing] efficient entry
and utilization of the telecommunications infrastructure.”
Order ¶ 630 (emphasis added). The Commission also says
that “the prices that potential entrants pay for these ele-
ments should reflect forward-looking economic costs in order
to encourage efficient levels of investment and entry.” Id.,
¶ 672 (emphasis added). And it adds that “Congress spe-

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cifically determined that input prices should be based on
costs because this would foster competition in the retail
market.” Id., ¶ 710; see also id., ¶ 1.
Fifth, the Solicitor General confirmed this view at oral
argument when he said that the rates in question should
be set in order to “encourage new entrants to come into
the market,” Tr. of Oral Arg. 60, to “allow them to enter the
market at competitive rates,” ibid., and to “encourage them
to develop new technologies,” id., at 61.
The statute, then, seeks new local market competition in-
sofar as local markets can support that competition without
serious waste. And we must read the relevant ratesetting
provision—including the critical word “cost”—with that goal
in mind.
III
The Commission’s critics—Verizon, other incumbents, and
experts whose published articles Verizon has lodged with
the Court—concede that the statute grants the Commission
broad authority to define “cost[s].” They also concede that
every ratesetting system has flaws. Cf., e. g., Missouri
ex rel. Southwestern Bell Telephone Co. v. Public Serv.
Comm’n of Mo., 262 U. S. 276, 311–312 (1923) (Brandeis, J.,
joined by Holmes, J., dissenting) (criticizing “reproduction
cost” systems because of the administrative difficulty of de-
termining costs); Economics of Regulation 109–111 (criti-
cizing “historical cost” systems because of their failure to
provide proper incentives).
Nonetheless, the critics argue, the Commission cannot law-
fully choose a system that thwarts a basic statutory purpose
without offering any significant compensating advantage.
They take the relevant purpose as furthering local compe-
tition where feasible. See Part II, supra. They add that
rates will further that purpose (1) if they discourage new
firms from using the incumbent’s facilities or “elements”
when it is significantly less expensive, economically speak-
ing, for the entrant to build or to buy elsewhere, and (2) if

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they encourage new firms to use the incumbent’s facilities
when it is significantly less expensive, economically speak-
ing, for the entrant to do so. They point out that prices
that approximately reflect an actual incumbent’s actual
additional costs of supplying the services (or “element”)
demanded will come close to doing both these things. See
Kahn 330 (prices set at “incremental cost,” the cost of sup-
plying an added “increment,” will give challengers the
“proper target at which to shoot” only if that cost reflects
“the cost that society will actually incur if they pur-
chase more” or the resources that it would save if they
purchase less); Knieps, Interconnection and Network Access,
23 Ford. Int’l L. J. 90 (2000); see also J. Sidak & D. Spulber,
Deregulatory Takings and the Regulatory Contract (1998)
(arguing that a market-determined efficient component pric-
ing rule (M–ECPR) satisfies these objectives and that the
FCC has misunderstood the M–ECPR system). But prices
like the Commission’s, based on the costs that a hypothetical
“most efficient” firm would incur if hypothetically building
largely from scratch, Order ¶ 685, would do neither. Indeed,
they would do exactly the opposite, creating incentives that
hinder rather than further the statute’s basic objective.
First, the critics ask, why, given such a system, would a
new entrant ever build or buy a new element? After all,
the Commission’s ratesetting system sets the incumbent’s
compulsory leasing rate at a level that would rarely exceed
the price of building or buying elsewhere. That is because
the Commission’s ratesetting system chooses as its basis
the hypothetical cost of the most efficient method of provid-
ing the relevant service—i. e., the cost of entering a house
through the use of electrical conduits or of using wireless
(if cheaper in general), and it then applies those costs (based
on, say, hypothetical wireless) as if they were the cost of
the system in place (the twisted pair of wires). Why then
would the new entrant use an electrical conduit, or a wireless
system, to enter a house when, by definition, the Commis-

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sion will require the incumbent to lease its pair of twisted
wires at an equivalent price or lower—whether or not the
incumbent will have to spend more, in fact, to provide the
twisted wires? The rules further discourage independent
building or buying by assessing a special penalty upon the
new entrant that does so, for that entrant will have to
worry that soon another newer new entrant will insist upon
sharing the incumbent’s equivalent of that very element at a
still lower regulation-determined price based on subsequent
technological developments.
The Commission’s system will tend to create instances in
which (1) the incumbent’s actual future cost of maintain-
ing an element (say, a set of wires) will exceed (2) the new
entrant’s cost of building or buying elsewhere (say, through
wireless or wires in electrical conduits) which, in turn, will
equal (or even exceed) (3) the hypothetical future “best prac-
tice” cost (namely, what the experts decide will, in general,
be cheapest). In such a case (or in related cases, where
technological improvements, actual or predicted, tend to
offset various cost differences), the new entrant will un-
economically share the incumbent’s facilities by leasing
rather than building or buying elsewhere. And that result,
in the assumed circumstances, is wasteful. It undermines
the efficiency goal that the majority itself claims the Act
seeks to achieve. Cf. ante, at 509–510, 539.
Nor is the “sharing” of facilities (e. g., the wire pairs)
that this result embodies consistent with the competition
that the Act was written to promote. That is because firms
that share existing facilities do not compete in respect to
the facilities that they share, any more than several grain
producers who auction their grain at a single jointly owned
market compete in respect to auction services. Cf. Iowa
Utilities Bd., 525 U. S., at 429 (Breyer, J., concurring in
part and dissenting in part) (“It is in the unshared, not in
the shared, portions of the enterprise that meaningful com-
petition would likely emerge”). Yet rules that combine a

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strong monetary incentive to share with a broad definition of
“network element,” see 47 CFR §§ 51.319(f)–(g) (1997); Order
¶ 413, will tend to produce widespread sharing of entire
incumbent systems under regulatory supervision—a result
very different from the competitive market that the statute
seeks to create. See Iowa Utilities Bd., supra, at 386–387
(affirming the Commission’s broad definition of “network ele-
ment”). At the least, those rules are inconsistent with the
Commission’s own view that they will sometimes “serve as
a transitional arrangement until fledgling competitors could
develop a customer base and complete the construction of
their own networks.” In re Implementation of the Local
Competition Provisions of the Telecommunications Act of
1996, 15 FCC Rcd. 3696, 3700, ¶ 6 (1999) (Third Report and
Order). Why, given the pricing rules, would those “fledg-
ling competitors” ever try to fly on their own?
Second, what incentive would the Commission’s rules
leave the incumbents either to innovate or to invest in a new
“element?” The rules seem to say that the incumbent will
share with competitors the cost-reducing benefits of a suc-
cessful innovation, while leaving the incumbent to bear the
costs of most unsuccessful investments on its own. But see
infra, at 552. Why would investment not then stagnate?
See, e. g., Jorde, Sidak, & Teece, Innovation, Investment, and
Unbundling, 17 Yale J. Reg. 1, 8 (2000) (“It makes no
economic sense for the [incumbent] to invest in technologies
that lower its own marginal costs, so long as competitors
can achieve the identical cost savings by regulatory fiat”);
Sidak & Spulber, Deregulation and Managed Competition in
Network Industries, 15 Yale J. Reg. 117, 124–125 (1998) (“If
deprived of a return to capital facilities after capital has been
sunk in irreversible investments, or if faced with reduced
returns to investments already made, any economically ra-
tional company will eliminate or reduce similar capital in-
vestments in the future”); Armstrong, AT&T Scoffs at Possi-
ble Common Carrier Status, Telecommunications Reports,

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Nov. 9, 1998 (Chief Executive Officer of AT&T, which here
supports the Commission’s regulations), cited in Huber 206,
n. 611 (“ ‘No company will invest billions of dollars . . . if
competitors who have not invested a penny of capital, nor
taken an ounce of risk, can come along and get a free ride on
the investments and risks of others’ ”).
I recognize that no regulator is likely to enforce the Com-
mission’s rules so strictly that investment literally slows
to a trickle. Indeed, the majority cites figures showing
that in the past several years new firms have invested $30
to $60 billion in local communications markets. See ante, at
516. We do not know how much of this investment rep-
resents facilities, say, broadband, for which an incumbent’s
historical network offers no substitute. Nor do we know
whether this number is small or large compared with what
might have been. Cf. FCC, Statistics of Communications
Common Carriers 51 (table 2.7); FCC, Statistics of Communi-
cations Common Carriers 42 (table 2.7); FCC, Statistics of
Communications Common Carriers 29 (table 2.7); FCC, Sta-
tistics of Communications Common Carriers 1 (table 2.7) (in-
cumbents’ similar investment over the same period amounts
to over $100 billion); cf. FCC, 2000/2001 Statistics of Commu-
nications Common Carriers 51 (table 2.9) (total depreciated
investment plus working capital equals $220 billion); ante, at
516, 521 (new entrants’ market share provided by entrants’
own facilities alone is 33%). Regardless, given the incen-
tives, this independent investment would seem to have been
made despite the “start from scratch” rules, not because of
them. At best, such statistics do no more than show that at
least some of the coincidences I describe below have, happily
for the Commission and the public alike, come to pass. See
infra, at 554, 556, 560–561.
The critics mention several other problems as well. They
say, for example, that the Commission’s regulations will ex-
acerbate the problem of “stranded costs”—i. e., the need for a
once-regulated incumbent to recover its reasonable, but now

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technologically outdated, historical investment. See Part
III–C, ante. They add that the regulations will make nearly
redundant the statute’s provisions for “element” rates set
through negotiation. See 47 U. S. C. § 252(a)(1). After all,
given the Commission’s regulations, how much is there to
negotiate about? The regulations entitle the new entrant
to a price equal to, or lower than, the price to which any
rational incumbent could agree. See Brief for United States
in Mathias v. Worldcom Technologies, Inc., O. T. 2001,
No. 00–878, p. 18, n. 5 (“[A]s a practical matter” carriers have
little incentive to negotiate).
Nor, in the critics’ view, do the regulations possess any
offsetting advantages. They lack that ease of administra-
tion that led Justices Holmes and Brandeis to favor use
(for ratesetting purposes) of an incumbent’s historic costs
despite their economic inaccuracy. See Southwestern Bell
Telephone Co., 262 U. S., at 292–296 (dissenting opinion); see
also ante, at 481–483. The hypothetical nature of the Com-
mission’s system means that experts must estimate how
imaginary firms would rebuild their systems from scratch—
whether, for example, they (hypothetically) would receive
permission to dig up streets, to maintain unsightly telephone
poles, or to share their pole costs with other users, say,
cable operators—and they must then estimate what would
turn out to be most “efficient” in such (hypothetical) future
circumstances. The speculative nature of this enterprise,
the critics say, will lead to a battle of experts, each asking
a commission to favor what can amount to little more than a
guess. See Kahn 333, 334, n. 36, 335 (describing three mod-
els introduced in regulatory proceedings, one of which re-
duced all actual expenses by 27% because railroad regulation
had brought similar efficiency gains, another of which as-
sumed that all utilities, including electricity producers,
would rebuild entire systems from scratch at the same time,
and the third of which assumed New Hampshire’s tele-
communications system was administratively most efficient
but then reduced its actual administrative expenses by 25%).

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These administrative difficulties seem far greater than any
difficulty likely involved in an effort to determine an actual
incumbent’s actual (past or likely future) costs. See Affi-
davits of W. Baumol, J. Ordover, & R. Willig, Comments of
AT&T Corp., CC Docket 96–98: In the Matter of Implemen-
tation of Local Competition Provisions in the Telecommuni-
cations Act of 1996, ¶ 25 (May 16, 1996), App. 67 (TELRIC’s
estimates “do not simply accept the architecture, sizing,
technology, or operating decisions” of the incumbents “as
bases for calculating” costs). Assumptions are inevitable.
And the resulting uncertainties mean a somewhat random
sort of rate that can either exacerbate the incentive prob-
lems previously mentioned or alleviate those problems by
a kind of regulatory coincidence. See ante, at 522 (describ-
ing how state commissioners “customarily assig[n] rates
based on some predictions from one model and others from
its counterpart”).
IV
The criticisms described in Part III are serious, poten-
tially severing any rational relation between the Com-
mission’s regulations and the statutory provision’s basic
purposes. State Farm, 463 U. S., at 56. Hence, the Com-
mission’s responses are important. Do those responses re-
duce the force of the criticisms, blunt their edges, or sug-
gest offsetting virtues? I have found six major responses.
But none of them is convincing.
First, the FCC points out that rates will include not only
a charge reflecting hypothetical “most-efficient-firm” costs
but also a depreciation charge—a charge that can reconcile
a firm’s initial historic investment, say, in equipment, and
the equipment’s current value, which diminishes over time.
See Order ¶ 686 (“[P]roperly designed depreciation sched-
ules should account for expected declines in the value of
capital goods”). If, for example, an incumbent’s reason-
able investment, measured actually and historically, came
to $50 million, but FCC experts predict a “most-efficient-

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firm-building-from-scratch” future replication cost of $30 mil-
lion, a depreciation charge could permit the incumbent to
recoup the otherwise missing $20 million. And, in theory,
a state commission might structure a potentially complex
depreciation charge so as both to permit recovery of historic
investment and also to offset many of the improper invest-
ment incentives described in Part II, supra.
This response, however, does not reflect what the Com-
mission’s regulations actually say. Those regulations say
nothing about permitting recovery of reasonable historic
investment nor about varying the charge to offset perverse
investment incentives. Rather, they strongly indicate the
opposite. They clearly require state commissions to use
current depreciation rates right alongside the Commission’s
new and different “most-efficient-firm-building-from-scratch”
charges. See Order ¶ 702. They do create an exception
from “current” rates. But to take advantage of that ex-
ception “incumbent LECs” have to bear the “burden of
demonstrating with specificity that the business risks that
they face in providing unbundled network elements and
interconnection services would justify a different . . . de-
preciation rate.” Ibid. Unless the exception is to swallow
the rule, the term “business risks” must refer to some spe-
cial situation—not to the ordinary circumstance in which a
new entrant simply asks to share an “element” at rates
determined under Commission “most-efficient-firm” rules.
In any event, that is how 24 state commissions have read the
language. See 1998 Biennial Regulatory Review—Review
of Depreciation Requirements for Incumbent Local Ex-
change Carriers, 15 FCC Rcd. 242, ¶ 69 (1999). And the
FCC nowhere explicitly says to the contrary. Hence the
FCC depreciation rules as written do not respond to the
critics’ claims in the ordinary case, nor do they otherwise
transform its “most-efficient-firm-building-from-scratch” sys-
tem into a system that reflects historic costs.

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Second, the FCC points out that a state commission can
adjust permissible profit rates. In theory, such an adjust-
ment could offset many of the improper investment incen-
tives described in Part II, supra. But, like the deprecia-
tion regulations, the profit regulations say nothing about
the matter. Indeed, like the depreciation regulations, they
suggest the opposite. The relevant FCC regulations say
that “the currently authorized rate of return at the federal
or state level is a reasonable starting point.” Order ¶ 702
(emphasis added). They, too, add an exception, available to
“incumbent LEC’s” that successfully “bear the burden of
demonstrating with specificity that the business risks that
they face in providing unbundled network elements and
interconnection services would justify a different risk-
adjusted cost of capital.” Ibid. But this exception, like the
depreciation exception, cannot respond to the critics’ claims
in the ordinary case for similar reasons.
The FCC adds that it did not have “time” to offer more
than “tentative guidance,” Reply Brief for Federal Parties
11–12, that profits now may be too high, Order ¶ 702, and
that the incumbents may find other ways to lower their capi-
tal costs, id., ¶ 687. These additions, however, concede the
critics’ basic point—that the “profit” rules as written do not
provide an answer to Part III’s claims. Rather, considered
as a response to those claims, they must rest upon no more
than hope for a regulatory coincidence. Most significantly,
they hope that current market conditions mean that current
profit rates somehow magically offset the adverse effects
of the Commission’s other regulations, see Part III, supra.
See Reply Affidavit of J. Hausman ¶ 9, n. 8, submitted with
Reply Comments of the United States Telcom Association,
CC Docket No. 96–98 (FCC filed May 30, 1996), App. 197
(testifying for critics that profit rates would have to double
or triple to secure investment). Cf. G. Hubbard & W. Lehr,
Capital Recovery Issues in TELRIC Pricing: Response to
Professor Jerry A. Hausman (July 18, 1996), App. 216, 221

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(arguing for FCC defenders that Hausman overstates the
need for change, but stating that “if any adjustments . . . are
required . . . such adjustments would be modest”). And the
majority relies on its belief that that hope has been realized.
Ante, at 521 (stating that in light of the fact that “competi-
tion in fact has been slow to materialize,” “it seems fair to
say” that the current rate is a “ ‘reasonable starting point’ ”).
Of course, one must sympathize with the FCC’s time prob-
lem. But the statute did not require the FCC so quickly to
create so complex a system. Rather, the statute seems to
foresee rates set, not by FCC regulations primarily or in
detail, but by negotiations among the parties, 47 U. S. C.
§ 252(a)(1), if not by state commissions. See Iowa Utilities
Bd., 525 U. S., at 412–420 (Breyer, J., concurring in part and
dissenting in part).
Third, the Commission supports the reasonableness and
practicality of its system with the claim that “a number of
states” have used it successfully, as have several European
nations. Order ¶ 681. As to domestic experience, I can
find no evidence that, prior to the promulgation of the
rules at issue here, any State had successfully implemented
the FCC’s version of TELRIC. It is hardly surprising that
since then several States have tried to apply it. Nor is it
surprising that their implementation has produced criticisms
similar to those made here. See, e. g., MCI Telecommuni-
cations Corp. v. GTE Northwest, Inc., 41 F. Supp. 2d 1157,
1168–1169, and n. 7 (Ore. 1999) (discussing problems with the
FCC’s TELRIC).
And the “foreign nation” part of the Commission’s claim
rests only upon a 1997 European Community paper referring
to a “best current practice” approach as a future goal. See
Commission of European Communities, Recommendation
on Interconnection in a liberalised telecommunications mar-
ket, C(97) 3148, §§ 3.3, 3.5 (Oct. 15, 1997), http://europa.eu.int/
ISPO/infosoc/telecompolicy/en/r3148-en.htm (Apr. 17, 2002).
Indeed, Britain’s FCC counterpart has said that, in the

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absence of a showing of inefficiency, the incumbent’s ac-
tual current expenditures on capacity additions should be
used “as the starting point.” See Office of Telecommuni-
cations (Oftel), Access to Bandwidth: Indicative prices and
pricing principles ¶ 9 (May 2000), http://www.oftel.gov.uk/
publications/ broadband/llu/llu0500.htm (Apr. 17, 2002).
In fact, as I understand the European system, it may
turn out in practice to work roughly as follows: The relevant
European regulatory agency, seeking competition, encour-
ages new firms to enter local markets in order to provide
new voice, data, text, picture, entertainment, or other com-
munications service. Like the Commission, the agency nor-
mally has the authority to insist that an incumbent firm
“unbundle,” e. g., that it permit a new entrant to use its pair
of twisted wires running from switching center to the inside
of a house. It also has the authority to set prices. But in
exercising that authority, it has neither required, nor is it
likely to rely upon, any one ratesetting method. Rather, it
may encourage negotiation among the parties in order to
reach agreed-upon prices low enough to prevent the in-
cumbent from blocking entry but high enough to encourage
the new firm to consider other entry methods, such as use
of electricity conduits, or new cables, where economically
feasible. If no agreement can be reached, the regulator, in
determining the price, can use formulas, modified to take
proper account of depreciation and historical cost, or it can
look to prices set in other European nations as a yardstick
to help produce competition.
This less formal kind of “play it by ear” system, in my
view, is what the statute before us intended. The Act pro-
vides for price negotiation among the parties, it brings in
state regulators where necessary to break deadlocks, and it
permits the States to use a variety of different ratesetting
approaches, looking to experience in other States as appro-
priate, in order to determine proper prices. The mysterious
statutory parenthetical phrase “(determined without ref-

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erence to a rate-of-return or other rate-based proceeding),”
§ 252(d)(1), makes sense from this point of view. It reflects
Congress’ desire to obtain not perfect prices but speedy re-
sults. It specifies that States need not use formal methods,
relying instead upon bargaining and yardstick competition.
See Iowa Utilities, supra, at 424–425 (Breyer, J., con-
curring in part and dissenting in part); cf. Order ¶ 631 (de-
scribing how the New York Commission “se[t] prices on
a case-by-case basis”). I recognize, however, that the FCC
has rejected this approach in favor of extraordinarily com-
plex national ratesetting standards, which we review only to
determine whether they will further, or serve as obstacles
to, the competitive marketplace that the statute seeks.
Fourth, the FCC adds that its system seeks to base rates
on the costs a hypothetical “most efficient firm” hypotheti-
cally would incur were it “building from scratch.” And such
a system, in its view, will “simulate” or “best replicat[e], to
the extent possible, the conditions of a competitive market.”
Order ¶ 679; see also id., ¶ 738. This response, however,
does not do more than describe that very feature of the sys-
tem upon which the critics focus their attack.
As I have previously said, supra, at 543, such an objective
is perhaps consistent with an ordinary ratesetting statute
that seeks only low prices. But the problem before us—that
of a lack of “rational connection” between the regulations
and the statute—grows out of the fact that the Telecommuni-
cations Act is not a typical regulatory statute asking regula-
tors simply to seek low prices, perhaps by trying to replicate
those of a hypothetical competitive market. Rather, this
statute is a deregulatory statute, and it asks regulators to
create prices that will induce appropriate new entry. See
Part II, supra. That being so, we may assume, purely for
argument’s sake, that the FCC rules could successfully “rep-
licate” the prices toward which perfectly efficient, perfectly
competitive markets would tend. But see Kahn 326–327
(stating that such prices are never achieved in any actual

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market); A. Kahn, Whom the Gods Would Destroy, or How
Not to Deregulate 4 (2001) (stating that a firm in an actual
market would determine efficient investment in light of its
actual system, not a hypothetical system built from scratch).
Still, those rules, if successful, would produce the strong in-
centives to demand sharing, and the strong disincentives to
build independently, that Part II describes—for they would
create a “sharing” or “interconnection” price equal to or
lower than any price associated with the creation of inde-
pendent facilities. They would thereby tend toward a sys-
tem in which regulatory price setting would supplant, not
promote, competition. And however congenial institutional
regulators might find such a system, it differs dramatically
from the system that the statute seeks to bring about. See
Part II, supra. Cf. Iowa Utilities Bd., 525 U. S., at 387–392
(setting aside Commission rules granting new entrants
power to obtain access to virtually any existing element).
At least that is the claim that underlies much of the criticism
set forth in Part III, supra. And the Commission’s response
that its system simulates the conditions of a competitive
market does not respond to that basic criticism.
Fifth, the Commission says that its regulations are simply
suggestive, leaving States free to depart. Reply Brief for
Federal Parties 11–12. The short but conclusive answer to
this response is that the Commission considered a “sugges-
tive” approach and rejected it. See Order ¶ 66 (refusing to
characterize rules as setting forth, not “requirements,” but
“ ‘preferred outcomes,’ ” because the latter approach “would
fail to establish explicit national standards for arbitration,
and would fail to provide sufficient guidance to the parties’
options in negotiations”).
Sixth, the majority (but not the Commission) points out
that local commissions are likely to leave any given set of
rates in effect for some period of time. And this “regulatory
lag” will solve the problem. See ante, at 505–506. I do not
understand how it could solve the main problem—that of

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561 Cite as: 535 U. S. 467 (2002)
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leading new entrants to lease a more costly incumbent “ele-
ment” where building or buying independently could prove
less costly. See supra, at 548–550. Nor, given any new en-
trant’s legal right to obtain a regulator’s decision, am I cer-
tain that lags will prove significant. But, in any event,
lags will differ, depending upon regulator, time, and cir-
cumstance, thereby introducing a near random element
that might, or might not, ameliorate the system’s otherwise
adverse effects.
In sum, neither the Commission’s nor the majority’s re-
sponses are convincing.
V
Judges have long recognized the difficulty of reviewing
the substance of highly technical agency decisionmaking.
Compare Ethyl Corp. v. EPA, 541 F. 2d 1, 66 (CADC 1976)
(en banc) (Bazelon, C. J., concurring) (“[T]he best way for
courts to guard against unreasonable . . . administrative de-
cisions is not . . . themselves to scrutinize the technical
merits . . . [but to] establish a decision-making process
that assures a reasoned decision” (internal quotation marks
omitted)), with id., at 69 (Leventhal, J., concurring) (stating
that judges must assure, on substantive review, “conform-
ance to statutory standards and requirements of rationality,”
acquiring “whatever technical background is necessary”).
This Court has emphasized the limitations the law imposes
upon judges’ authority to insist upon special agency proce-
dures. Vermont Yankee Nuclear Power Corp. v. Natural
Resources Defense Council, Inc., 435 U. S. 519, 543–548
(1978). But it has also made clear that judges nonetheless
must review for rationality the substance of agency deci-
sions, including technical decisions. State Farm, 463 U. S.,
at 56. That review requires agencies to undertake the dif-
ficult task of translating technical matters into language
that judges can understand and preparing technical re-
sponses to challenges of the sort found here. But, despite
the difficulty, review by generalist judges is important, both

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Opinion of Breyer, J.
because technical agency decisions are often of great impor-
tance to the general public and because the law forbids agen-
cies, in the name of technical expertise, to wrest themselves
free of public control.
Agencies are, of course, expert in technical areas. That
is why Judge Leventhal wrote that “the judges,” when re-
viewing the rationality of substantive decisions, “must act
with restraint.” Ethyl Corp., 541 F. 2d, at 69. And I agree.
But, he added, judges may not “abstain from any substan-
tive review.” Id., at 68. And again I agree. In these
cases, the critics’ claims are strong. They suggest that the
FCC’s pricing rule, together with its original “forced leas-
ing” twin, see Iowa Utilities Bd., supra, at 388–392 (finding
original leasing rule unlawful), would bring about, not the
competitive marketplace that the statute demands, but a
highly regulated marketplace characterized by widespread
sharing of facilities with innovation and technological change
reflecting mandarin decisionmaking through regulation
rather than decentralized decisionmaking based on the inter-
action of freely competitive market forces. And the Com-
mission’s replies are unsatisfactory. The majority nonethe-
less finds the Commission’s pricing rules reasonable. As a
regulatory theory, that conclusion might be supportable.
But under this deregulatory statute, it is not. Under these
circumstances, it would amount to abstention from, indeed
abdication of, “rational basis” review, were I to agree that
the record here demonstrates the “rational connection” be-
tween regulations and statutory purpose upon which the law
insists. State Farm, supra, at 56; Administrative Procedure
Act, 5 U. S. C. § 706(2)(A); see also State Farm, supra, at 43
(“[W]e may not supply a reasoned basis for the agency’s ac-
tion that the agency itself has not given”). As Judge Leven-
thal properly put it, “Restraint, yes, abdication, no.” Ethyl
Corp., supra, at 69. The Court, of course, with 65 pages of
careful analysis, does not abdicate its reviewing responsi-
bility; but for the reasons stated here I cannot agree with

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its substantive conclusion. Consequently, I would affirm
the Eighth Circuit’s determination that the regulations are
unlawful.
VI
I disagree with the majority about one further legal issue.
The statute imposes upon an incumbent the
“duty to provide . . . for the provision of a telecommu-
nications service, nondiscriminatory access to network
elements on an unbundled basis . . . in a manner that
allows requesting carriers to combine such elements
in order to provide such telecommunications service.”
47 U. S. C. § 251(c)(3) (emphasis added).
The FCC, pointing to this provision, has said that (upon re-
quest) incumbents must themselves combine, among other
things, elements that are ordinarily not combined. Rules
315(c)–(f), 47 CFR §§ 51.315(c)–(f) (1997). How, the incum-
bents ask, can a statute that speaks of the requesting car-
riers combining elements grant the FCC authority to insist
that they, the incumbents, combine the elements?
In Iowa Utilities Bd., the Court found authority for a
somewhat similar rule—a rule that forbids incumbents to
uncombine elements ordinarily found in combination. But,
as the majority recognizes, ante, at 534–535, that different
rule rests upon a rationale absent here. If an incumbent
takes apart elements that it ordinarily keeps together, it
is normally discriminating against the requesting carriers.
And the statutory provision forbids discrimination. But
here the incumbent simply keeps apart elements that it ordi-
narily keeps apart in the absence of a new entrant’s demand.
How does that discriminate? And if it does not discrimi-
nate, where does this statutory provision give the FCC au-
thority to forbid it?
I cannot find the statutory authority. And I consequently
would affirm the lower court on the point.
For these reasons, I dissent.