A big part of my daily consulting life is helping entities like municipalities and rural electric cooperatives find ways to enter the broadband business. The majority of these entities consider partnerships as an alternative to becoming an ISP. While there are no two partnerships that are exactly alike, today’s blog looks at the predominant types of partnerships that I see being created.
Operator. The simplest kind of partnership is for somebody to build a network and hire an ISP to operate it. Entities like cities are often leery about becoming an ISP and are a lot more comfortable building a fiber network if somebody with a proven track record operates the business.
In this kind of relationship, the operator is largely a vendor for hire and doesn’t invest in the business. The operator gets compensated through management fees for operating the business and often will also be compensated by some sort of profit-sharing.
This arrangement is attractive to some ISPs because they have no financial risks. Since the operator makes no investment, they are not going to have a downside if the business underperforms, other than reduced fees and profit-sharing. Perhaps the biggest advantage to an operator is that their existing business gains economy of scale. The operator can spread overhead costs over the new business and reduce the overheads that apply to other parts of their business.
In this arrangement, the network owner is responsible for all operating costs. Hiring an operator can be a costly alternative since network owners are on the hook to pay the operator even if the business underperforms. This business structure only makes financial sense for a business that will generate enough profit to be able to afford the extra payments to the operator.
Partner Covers Customer Costs. The most common kind of partnership I’m seeing is where one entity builds the core network and a partner pays for the capital cost of adding customers to the network. The biggest variable in this arrangement is how much cost the partner covers. At a minimum a partner would cover the cost of everything inside the customer premise. At the other extreme is a dark fiber network where the operating partner covers everything from the curb and also the cost of lighting the network.
This arrangement flips the responsibilities compared to the operator model. The ISP that builds at the home is normally responsible for all operating costs associated with customers, and for that risk, they collect all revenues. The network owner gets compensated by some sort of lease and might benefit at some point in profit sharing.
The stickiest issue for creating this kind of partnership is figuring out how to compensate the network owner during the first few years of the partnership until there are sufficient customer revenues to cover the full cost of financing the network. At the one extreme the network owner makes the early debt payment out of pocket. In the other extreme the operating ISP pays the early debt payments before there are revenues. In both cases, this big early cost is one of the biggest challenges in creating this kind of business structure.
Equal Partners. The least common kind of partnership is a true partnership where two entities form a partnership and fund and operate the network as full partners. This structure generally means forming a new corporation where an ISP and a city or a cooperative each own some share of the business. In this arrangement, the partners share in gains or losses.
Who operates the business is open to negotiation and there could be staff provided by both entities or the business could hire all new staff.
I think true partnerships are rare because it’s hard for disparate entities like cities and ISPs to govern a business together. A commercial ISP likely has different goals than a city or an electric cooperative. For example, a commercial ISP might want to flip the business in 7-10 years to realize a full return on their investment while cities and cooperatives are in the business for the long haul. In some states it’s a challenge for a city to own part of a commercial business. Cities can also be unreliable partners since they can change drastically with a change of administration.
It’s hard to manage this kind of business jointly. Cities and cooperatives typically aren’t as nimble in their ability to make quick business decisions that a commercial partner is going to expect. The partners are also likely to have different views on what to do with profits or for issues like setting rates.
I’ve found that a successful partnership requires partners that share the same vision for the business, and it’s hard to find a commercial ISP that can share a vision with a city or a cooperative. Over the years I’ve seen several such partnerships created that either became rancorous after only a few years or which split apart when it became obvious that the partners had a different view of operating a business.