ting costs. The preceding discussion demonstrates that wholesale access represents a sub- stantial increase in transaction costs in comparison with the internal costs of a vertically integrated telecommunications company. The incumbent telecommu- nications company experiences little or no reduction in costs from the partial outsourcing of the retail function but substantial incremental costs of modifying systems to give wholesale access to internal management and service systems and Networks in Telecommunications incremental costs of systems for interfacing with competitors. CLECs also incur substantial transaction costs to gain access to ILECs' OSSs. Thus, total costs rise because of higher incremental transaction costs. The problem is that the approach to pricing wholesale access created by the 1996 Act ignores the impact of transaction costs. As noted earlier, the Act requires state PUCs to base wholesale rates on retail rates less avoided costs, defined to be the costs "that an incumbent LEC would no longer incur if it were to cease retail operations and instead provide all of its services through resellers" (FCC 1996a, p. 15956). This approach mistakenly ignores the transaction costs associated with wholesale access to resellers (Larson 1997; Larson and Mudd 1999). Thus, the proper discount should be based on net avoided costs: Discount = Avoided Retail Transactions Costs - Incremental Wholesale Transaction Costs. The 1996 Act and the FCC consider only the positive component of avoided costs. The discussion in this section has two main implications. First, the discount based on avoided retailing costs is likely to be low because ILECs continue to per- form many retail functions and thus avoid very few costs. Second, the incremental transaction costs of selling wholesale services are likely to be high because ILECs must reconfigure their OSSs and develop new systems for EDI with CLECs and for provisioning services within its network. Therefore, properly calculated avoided costs may be small or even negative i