When to Raise Rates

I’ve been getting the question lately about raising broadband rates. I don’t think there is a decision that smaller ISPs agonize over more than the idea of increasing prices to customers. The question is obviously being raised now due to inflation. Small ISPs see their costs increasing for fuel, materials, and requests from employees for salary increases – and ISPs see margins shrinking.

The current economy is particularly traumatic for newer ISPs who haven’t gone through an inflationary period before. It’s not particularly comforting to them to hear that over the life lifecycle of the economy that periodic bouts of inflation are normal. For most of my career, I’ve seen a recession and a period of inflation roughly every ten years. Inflation was never fun, but it was never unexpected.

We’ve just lived through one of the most unusual economic periods of the last few centuries. Everything we came to expect as normal, like periods of inflation and fluctuating interest rates has not happened for over a decade. The U.S. economy has never had such a stable and ideal period where the economic outlook was completely predictable – and good. Much of what we experienced came through government actions to suppress interest rates, to the point that the federal reserve interest rate even went negative for a short time.

ISPs worry about how customers will react to price increases. ISPs fear they will lose customers to competitors if they raise rates even a little. I can remember working with a client over twenty years ago who agonized for over a year about a $1 increase in telephone rates. They were sure that would drive consumers to drop telephone service in droves. It turns out that nobody dropped telephone service after the rate increase.

I hate to say this, but we can learn a lesson from the biggest ISPs. The big cable companies have been raising rates aggressively for the last five years – not in reaction to higher costs but strictly to drive up profits and improve stock prices. If you look back twenty years, you’ll see the all-in rates for broadband from companies like Comcast and Charter have risen at least $20 per month. The big ISPs are often sneaky about the increases and hide a lot of the rate increases in things like the cost of the broadband modem – but the checks that customers write have gone up every year.

A more salient example is the cellular carriers. Verizon and AT&T both recently announced rate increases – and these companies are now in a highly competitive market. Their reasoning is that they will lose some customers with a rate increase, but the gains from the customers that remain make the increase worthwhile. Small ISPs have to think of rate increases in the same way – you might lose a few customers, but the alternative is to do nothing and watch costs catch up to revenues.

Most other industries don’t agonize about rate increases in the way that ISPs do. If underlying costs go up, the makers of cereal, soap, and most things we buy raise rates to match. It’s always surprised me that very few small ISPs get this. Rate increases don’t have to be large, and an ISP might not be staring at a rate increase today if it had raised rates in prior years by a small amount each year when it was warranted. ISPs seem fixated on the concept that broadband prices must be at a value like $59.99 instead of $61.17. I really don’t know how that idea became so pervasive, but it’s a dumb one. Do ISPs really believe that consumers somehow equate $59.99 with fifty dollars and not sixty dollars? Because of this pricing paradigm, ISPs tend to wait until they have no choice and will raise the $59.99 rate to another magic number like $64.99 or even $69.99.

The need for rate increases during times of inflation is basic math. If your predominant product is broadband, and if costs are rising, you either raise rates or suffer a loss of margin – there isn’t any other alternative after you have done whatever belt-tightening you might do with expenses.

The only other alternative to rate increases is to sell a lot more broadband, but as broadband markets get mature, this gets to be harder to do. We are approaching a nationwide broadband penetration rate of 90%, and at some point, everybody who is willing to pay for broadband will have it.

My advice to ISPs has always been to make small rate increases over time, something small like 25 cents per year, rather than waiting until raising rates is a crisis and dramatic. But if you’ve waited until you have no option but to raise rates, then don’t be timid. Raise the rates to what is needed, and don’t be afraid to explain to your customers why you had to do so.

Do I Need to Insure My Network?

I periodically get asked about buying insurance to cover a new fiber network, mostly asked by investors or bankers who are working with a fiber network for the first time. The assumption is that there must be insurance to protect against damage to a fiber network because there is insurance for everything.

The surprising response I give them is to not try to buy insurance for a network. If you can even find an insurance company that will insure it, the premiums are going to be far larger than you can financially justify. The reality is that fiber and copper networks and electrical grids are not easily insured.

This horrifies a banker because they are lending money for an expensive asset. So how are network owners protected against losses?

Small damages to networks are generally recovered from the party that caused the damage. If a water company or electric utility cuts a buried fiber, that utility pays for the cost of the damage. This works the other direction also, and it’s rare to build a new fiber network without damaging a few other utilities during the process. This concept carries to everybody else. If a commercial truck knocks down a pole, the pole owner tries to get recovery from the insurance company of the truck owner. If a homeowner goes awry building a new driveway and badly damages the fiber network, that homeowner or his insurance covers the damage.

Big network damage is mostly covered by FEMA. If there is a big hurricane, ice storm, flood, fire, tornado, or other major events, then FEMA funding kicks in as long as the governor of a state has declared an emergency. I have had clients get fully reimbursed from FEMA in recent years for damage caused by the western fires, damage from a hurricane, and damage from a tornado. The FEMA paperwork process is not pretty, but the agency covers the cost of damage to utility infrastructure. In fact, the two biggest things that FEMA payouts often cover are damage to buildings and damage to utilities – that’s what gets damaged by storms.

There are other kinds of damage that don’t fit these two categories. For example, a small brush fiber caused by lighting might damage a short section of a pole line but not be large enough to kick in FEMA. Utilities are on the hook and self-insure for this kind of damage. They generally send out their own crews to get the damage fixed as quickly as possible, and nobody reimburses them for something like a local brush fire.

This is not to say that insurance isn’t important. Smaller ISPs generally buy insurance for all buildings, including all of the electronics inside them. You can get insurance to cover powered field huts. It’s important to make sure your insurance policy is specific and that you add new locations to your policy since property policies are often specific by the street address of the asset being insured. It’s not mandatory to buy such insurance, and many ISPs choose to self-insure. If you borrowed the money to build a network, you might be required to insure.

Note that most of the big ISPs don’t carry insurance. They self-insure because, over the long-run, it’s cheaper for a big telco or cable company to pay to repair things than it is to pay an insurance company every year. But smaller ISPs probably don’t have deep enough pockets to pick up the tab for replacing a central office or a NOC.

When insurance is optional, you should do the math. How do the premiums paid over some period like ten years compare to the cost of replacing the asset? That math gives you a numerical way to weigh the risk of insuring or not insuring a given asset.

Quantifying Grant Matching

Today’s blog is a math lesson, and I know that may turn off some readers immediately. But this is important math for anybody planning on funding a broadband project with a grant. The point of today’s blog is that somebody receiving a 75% grant must come up with more than 25% to match the grant.

The easiest way to illustrate this is with an example. Let’s say that somebody pursues a $10 million grant with one of the federal programs where the grant will cover 75% of a project. I’ve seen a few folks do the mental math and assume that means they must come up with $2.5 million as matching. That’s not enough money for several reasons.

First, grants don’t cover all assets. Most grants cover network assets and assets needed to connect to customers. But grants typically don’t cover vehicles, computers, furniture, test equipment, and any other assets needed to launch a new ISP or a new market. Grants also aren’t going to cover major software costs like upgrades to billing systems or marketing software – costs that an ISP will incur, but which are not eligible for grants.

There are also nuances of grants that you need to pay attention to. For instance, I know of several state grant programs that won’t cover assets like buying land to place huts.

Grants also cover only minimal amounts of expenses, but they don’t cover any of the costs of operating the business until the time that revenues are sufficient to cover expenses. Grants often cover the cost of preparing the grant, and some grants give some funding for the overhead costs of tracking future grant paperwork – but many don’t even cover this.

But grants don’t cover the big expenses of launching a new market. For a $10 million grant, that probably means hiring a few new technicians and customer service reps. A new market will certainly need a sales and marketing program. Grants won’t cover additional bandwidth or maintenance agreements on the new technology. Getting into a new market often means fees to consultants, lawyers, and accountants. And it means all of other operating costs like higher power bills, new cellphones, pole attachments, number portability, regulatory filings, higher fuel costs, and increases in insurance. Grants also are not going to cover the cost of financing – with the biggest expense usually being interest.

The amount of the uncovered costs will largely be a function of how long it takes to launch a new market and connect customers. Connect customers quickly, and the operating loss might be small. Get stuck with supply chain issues that delay construction after you’ve already hired a few new employees, and losses could be significant.

What might that look like in practice? The following example is based upon an actual projection for one of my clients:

Grant Eligible Assets                                       $10.0 M

Grant                                                                $  7.5 M

Unfunded Assets                                            $  2.5 M

Ineligible Assets                                             $  0.5 M

Operating Losses Until Breakeven              $  0.9 M

Total Project Costs                                        $11.4 M

Out of Pocket Costs                                      $  3.9 M

In this case, the $3.9 million is a lot more than the $2.5 million that might be the first guess of the out-of-pocket costs. My simple advice is: do the math!

New Middle-Mile Grants

One of the new programs established by the Infrastructure Investment and Jobs Act (IIJA) is $1 billion in grants to build middle-mile fiber. The grant program will be administered directly by the NTIA. The grant program defines middle-mile as any broadband infrastructure that does not directly connect to an end-user location. Projects that might be considered for the grants include building fiber, leasing of dark fiber, submarine cable, undersea cables, transport to data centers, carrier-neutral internet exchanges, and wireless microwave backhaul.

The amount of funding is disappointingly small. For comparison, the California legislature created a $3.25 billion middle-mile fund just within the state. Rural America is woefully underserved by middle-mile infrastructure. Rural communities can all attest to the pain of losing broadband, cellular coverage, and public safety systems anytime the backbone fiber into a rural area goes out of service.

The stated purpose of the grants is to reduce the cost of connecting unserved and underserved areas to the Internet and to promote resiliency – which is the phrase currently being used as a surrogate for redundancy. Resiliency means bringing a second transport route into an area so that a single fiber or microwave failure won’t strand a community without broadband.

The federal grants will provide up to 70% of the cost of constructing middle-mile connectivity. Priority will be given to projects that:

  • Leverage existing rights-of-way to minimalize regulatory and permitting challenges.
  • Enable the connection of unserved anchor institutions.
  • Facilitate the creation of carrier-neutral interconnection facilities (places where multiple carriers can meet and exchange traffic).
  • Improve the redundancy of existing middle-mile infrastructure.

Grant applicants must demonstrate financial, technical, and operational capability to be eligible. Grant applicants must also satisfy at least two of the following conditions (and more than two would be better):

  • Has a fiscally sustainable middle-mile strategy.
  • Will offer non-discriminatory access to other carriers and entities.
  • Projects which identify specific last-mile networks that will benefit.
  • Projects with identified investments or support that will accelerate the construction and completion of a project.
  • Projects that will benefit national security interests.

The NTIA is directed to prioritize grant applications that:

  • Connect middle-mile infrastructure to last-mile networks that plan to serve unserved areas.
  • Connect non-contiguous trust lands.
  • Offer wholesale broadband service to other carriers and entities.
  • Can complete the buildout in a timely manner.

It’s likely to be until late 2022 until the grant program is taking applications. While not gigantic compared to other parts of the infrastructure bill, this grant would still translate into 20,000 miles of middle-mile fiber at $50,000 per mile. These grants are going to most easily be awarded to solid financial recipients that have assembled a consortium of entities that will pledge to use the new middle-mile routes. I strongly suggest that regional groups start talking now to be ready when these grants when announced. At only $1 billion, it seems likely that there will only be one grant cycle.

Controlling Fiber Construction Costs

It’s obvious with all of the grant money coming downhill from the federal government that there is going to be a lot of fiber constructed over the next year or two, and much of it by municipalities or other entities that have not built fiber before. Today’s blog talks about issues that can increase the cost of building fiber – an important topic since cost overruns could be devastating to an entity that is largely funded with grants.

I think everybody knows of cases where the funding for infrastructures has gone off the rails, with the final cost of a project being much higher than what was originally funded. I can remember when I last lived near DC and watched the cost of a new Beltway bridge over the Potomac come in at more than twice the original cost estimate. I can remember instances of big cost overruns for infrastructure like schools and roads. Cost overruns can also easily happen on fiber projects.

The number one issue facing the whole industry right now is shortages in the supply chain. I have clients seeing relatively long delivery times for fiber and fiber electronics. New entities that have never built fiber are going to go to the end of the line for receiving fiber. To the extent that grant-funded projects come with a mandated completion date, this is going to be an issue for some projects.

But more importantly, labor-related costs for building fiber are going to rise (and have already started doing so). With a huge volume of new projects, there will be a big shortage of consultants, engineers, and construction contractors. Like always happens in times of high demand, this means labor rates are going to rise – and that’s even assuming you can find somebody to work on a small project. One of the hidden facts in the industry is that very few construction companies build 100% with staff and heavily rely on subcontractors. Those subcontractors are going to be bid away from small projects to get more lucrative work for big projects. Even ISPs that build with their own crews are going to see staff lured away by higher pay rates. If you estimated the cost of building fiber a few years ago, the labor component of those estimates is now too low. Another issue to consider is that some grants require paying labor at prevailing wages, which means at metropolitan rates. This alone can add 15% or more to the cost of a rural fiber project.

The biggest crunch will be consultants and engineers who work for smaller projects. I’m in this category. There are only a handful of good consultants and engineers and we’re already seeing that we are going to be swamped and fully booked before this year is over. Don’t be surprised if you hear that your preferred vendors are not taking on new business.

The other big gotcha in fiber construction projects is change orders. This means any event that gives a construction contractor a chance to charge more than the original proposed cost of construction. Using the example of the bridge that went over budget – most of the extra costs came through change orders.

There are construction firms that bid low for projects with the expectation that they’ll make a lot more from change orders. You want to interview other communities that used the contractors you are considering. But a lot of change order costs can be laid at the feet of the project owner. It’s not unusual to see a project go out to bid that is not fully engineered and thought through. Changing your mind on almost any aspect of a project can mean extra costs and cost overruns. Here are just a few examples of situations I have seen on projects that added to the costs:

  • After the first neighborhood of a project was built, the client decided that they didn’t like fiber pedestals and wanted everything put into buried handholes. That meant ripping and replacing what had already been built and completely swapping inventory.
  • A contractor ran into a big underground boulder that was incredibly difficult to bore through. This was a city network, and the city would not allow an exception to build shallower only at this boulder and insisted on boring through it – at a huge, unexpected cost.
  • I worked on a project where the original specification was to build past every home and business in the community. Once construction was started the client decided to build fiber to every street, including the ones with no current buildings. That’s a valid decision to make, but it added a lot to construction costs.

I could write a week worth of blogs listing situations that added to construction costs. The bottom line for almost all of these issues is that the fiber builder needs to know what they want before a project starts. There should be at least preliminary engineering that closely estimates the cost of construction before starting. Project owners also need to be flexible if the contractor points out opportunities to save costs. But my observation is that a lot of change orders and cost overruns come from network owners that don’t know what they want before construction starts.

Pricing Strategies

One of the things that new ISPs always struggle with is pricing, and I’m often asked advice on the right pricing strategy. It’s not an easy answer and in working across the country I see a huge range of different pricing strategies. It’s really interesting to see so many different ideas on how to sell residential broadband service, which is fundamentally the same product when it’s offered on a fiber network. The following are some of the most common pricing strategies:

High, Low, or Market Rates? The hardest decision is where to set rates in general. Some ISPs are convinced that they need low rates to beat the competition. Others set high rates since they only want to sell products with high margins. Most ISPs set rates close to the market rates of the competitors. I sat at a bar once with a few ISPs who argued this for hours – in the end, the beer won.

One Broadband Product. A few ISPs like Google Fiber, Ting, and a handful of smaller ISPs offer only a single broadband product – a symmetrical gigabit connection. Google Fiber tried going to a 2-product tier but announced this year that they’ve returned to the flat-rate $70 gigabit. The downside to this approach is that it shuts out households that can’t afford the price. The upside is that every customer has a high margin.

Simple Tiers. The most common pricing structure I see offers several tiers of prices. An ISP might have three-tier offerings at $55, $70, and $90, ranging from 100 Mbps to gigabit. Generally, such prices have no gimmicks – no introductory pricing, term discounts, or bundling. There are still ISPs with half a dozen, or even more tiers this would confuse me as a customer. For example, I don’t know how a customer would be able to choose between buying 75 Mbps, 100 Mbps, and 125 Mbps.

ISPs with this philosophy differ most by the gap between pricing tiers. Products could be priced $10 apart of $30 apart, and that makes a significant statement to customers. Small steps between tiers invite customers to upgrade, while bigger steps between tiers make a statement about the value of the faster speeds.

Low Basic Price. I’ve seen a number of ISPs that have a low-price basic broadband product, but otherwise somewhat normal tiers of pricing. This is done more often by municipal ISPs trying to make broadband affordable to more homes, but there are commercial ISPs with the same philosophy. As an example, an ISP might have an introductory tier of 25 Mbps for $40. This pricing strategy has always bothered me. This can be a dangerous product to offer because the low price might attract a lot of customers who would otherwise pay more. I’ve always thought that it makes more sense to offer a low-income product only to homes that qualify in some manner but give them real broadband.

Introductory Marketing Rate. Some ISPs set a low introductory rate for first-time customers. These rates are generally good for one or two years and customers routinely sign contracts to get the low rates. The long-term downside of this pricing philosophy is that customers come to expect low rates. Customers that take the introductory rate will inevitably try to renegotiate for continued low rates at the end of the contract period.

An ISP with this pricing structure is conveying some poor messages. First, they are telling customers that their rates are negotiable. They are also conveying the message that there is a lot of profits in their normal rates and they are willing to sell for less. Customers dislike the introductory rate process because they invariably get socked with an unexpected rate increase when rates jump back to list prices. The time of introductory discounts might be coming to an end. Verizon recently abandoned the special pricing strategy because it attracts low-margin customers that often leave at the end if the contract period.

Bundling. This is a pricing strategy to give a discount for buying multiple services and has been the bread and butter for the big cable companies. Bundling is making less sense in today’s market where there is little or no margin in cable TV. Most small ISPs don’t bundle and take the attitude that their list prices are a good deal – much the same as car dealers who no longer haggle over prices. In order to bundle, an ISP has to set rates high – and many ISPs prefer to instead to set fair rates and not bother with the bundle.

Look Out for those Grant Gotchas

One of the most disappointing things in the broadband world is when broadband grants have ‘gotchas’ that make it hard to use the money as intended. North Carolina has named its state broadband grant program the “GREAT” grants. That’s a pretty bold name, and I’m sure that the homes and businesses in the states that are getting broadband as a result of these grants think it’s great. But like other grant programs around the country, there are some gotchas in the grants.

Even though I live in North Carolina, I hadn’t looked into the details of the program until I got a call from a part-time professor at NC State. He was struggling while working at home due to COVID-19 and trying to hold remote college classes from a slow home broadband connection. He and his neighbors were upset because the State had awarded a grant in 2019 to bring broadband to his area of Caswell County, and yet nothing has happened. The rumor was that there was something amiss about the grant, but nobody locally knew why they weren’t getting broadband.

It didn’t take long to find that Open Broadband, a wireless ISP, had won a $1.54 million Great grant to bring broadband to 1,194 homes in the County – roughly one-fourth of the rural households in the county that the FCC says don’t have 25/3 broadband in the 2019 Broadband Deployment Report. This state grant was to have been matched with another $1.54 million from the ISP.

Open Broadband told me that the state had yanked the grant due to a change in the grant rules that was introduced after the grant award – a rule that had not been disclosed in the original grant rules. The state administrator of the grant, the Broadband Infrastructure Office, notified Open Broadband after the grant had been awarded that the ISP had to meet one of the following financial tests to receive the funds:

  • Letters from the applicant’s Board of Director or investors guaranteeing the total project cost.
  • A letter or actual statements from a bank or other financial institution verifying total available cash or lines of credit meet or exceed the anticipated total project costs.
  • Letters from a verifiable third-party entity guaranteeing the total project cost.

In case those rules didn’t sink in, the state is requiring an ISP to guarantee 100% of the cost of the project, including the portion of grant being supplied by the State. In this case, the state wants Open Broadband to guarantee over $3 million, even though they are only receiving $1.5 million of grant funding. Most grants that seek proof of financial viability would ask an ISP to guarantee their out of pocket costs – in this case that’s significantly less than $1.5 million since customer installation fees will cover a large portion of the ISP’s grant matching.

It’s ludicrous that the state wants an ISP to guarantee the portions of the grant paid by the State – is North Carolina worried that its own grant money is no good? The state wants Open Broadband to have $3.08 million in free cash or else a guarantee of that amount from a bank or a private investor. Whoever came up with this after-the-fact rule doesn’t understand ISPs or the banking industry.

ISPs don’t sit on much free cash – even fairly large ISPs. We are living at a time when every ISP I know is expanding – something that governments at all levels should support because government constantly says that the private sector should solve the broadband problems in rural America. Few ISPs are sitting on the free cash needed to make this guarantee.

The State will alternatively accept a guarantee from an owner or investor. This request is massively out-of-line with the nature of the project. A personal guarantee means putting your home and retirement savings on the hook. Many small and medium ISPs are already partially financed by personal loan guarantees by owners, and they can’t pledge this twice – even the rare owner that has over $3 million in net personal wealth.

The idea of an ISP having $3 million in an unused line of credit is even more absurd. Only a really large ISP would have a $3 million line of credit. A business line of credit is a loan that hasn’t yet been drawn. Banks are not like credit card companies and they don’t set big credit limits without an expectation that a borrower will use the money quickly.

The only other way to meet this requirement from a bank is with a bank letter of credit. A letter of credit is a formal negotiable instrument – a promissory note like a check. A letter of credit is a promise that a bank will honor the obligation of the buyer of letter of credit should that buyer fail to meet a specific obligation. Banks consider a letter of credit to be the equivalent of a loan. The banks must set aside the amount of pledged money in case they are required to disburse the funds. Most letters of credit are only active for a short, defined time. A letter of credit for a 2-year grant would be unusual and expensive – the ISP would likely to have to pay full interest expense as if this was a loan. The bottom line is that banks don’t issue a letter of credit for this kind of purpose.

I never heard of the concept of guaranteeing grants in this manner until last year. Out of the blue, the FCC suggested that winners of the $16.4 RDOF grants should be required to guarantee matching funds by either holding the cash or supplying a letter of credit. There was such an immediate outroar from the industry that this idea was killed in a matter of weeks. The industry conjectured that the idea came from the big ISPs, which have the FCC’s ear. The big ISPs know this requirement would stop most ISPs from applying for an RDOF grant – which would allow the incumbents to keep milking money out of rural properties with lousy and overpriced broadband. This may not be the reason for the North Carolina requirement, but the timing is suspicious.

This is not the only gotcha in the grant. The state also only reimburses funds that have been spent by a grant awardees once per quarter. Every other grant program I know of reimburses ISP expenses monthly. It’s a major financial penalty to make ISPs wait for months to get expenses reimbursed.

I was surprised to see major gotchas in North Carolina grants. This comes from a state that brags about its history of being first in broadband. For example, North Carolina says it was the first to have brought fast broadband to every school. I have no idea where the State got the idea for the grant guarantees, but it’s an absurd requirement that will do little more than discourage ISPs from investing in the state. ISPS can easily move across the border to nearby Virginia or Tennessee where the grant process is friendlier. North Carolina needs to kill this absurd rule. Those homes in Caswell County deserve the broadband they were promised, and it’s still not too late to make this grant work.

Expect a New Busy Hour

One of the many consequences of the coronavirus is that networks are going to see a shift in busy hour traffic. Busy hour traffic is just what is sounds like – it’s the time of the day when a network is busiest, and network engineers design networks to accommodate the expected peak amount of bandwidth usage.

Verizon reported on March 18 that in the week since people started moving to work from home that they’ve seen a 20% overall increase in broadband traffic. Verizon says that gaming traffic is up 75% as those stuck at home are turning to gaming for entertainment. They also report that VPN (virtual private network) traffic is up 34%. A lot of connections between homes and corporate and school WANs are using a VPN.

These are the kind of increases that can scare network engineers, because Verizon just saw a typical year’s growth in traffic happen in a week. Unfortunately, the announced Verizon traffic increases aren’t even the whole story since we’re just at the beginning of the response to the coronavirus. There are still companies figuring out how to give secure access to company servers and the work-from-home traffic is bound to grow in the next few weeks. I think we’ll see a big jump in video conference traffic on platforms like Zoom as more meeting move online as an alternative to live meetings.

For most of my clients, the busy hour has been in the evening when many homes watch video or play online games. The new paradigm has to be scaring network engineers. There is now likely going to be a lot of online video watching and gaming during the daytime in addition to the evening. The added traffic for those working from home is probably the most worrisome traffic since a VPN connection to a corporate WAN will tie up a dedicated path through the Internet backbone – bandwidth that isn’t shared with others. We’ve never worried about VPN traffic when it was a small percentage of total traffic – but it could become one of the biggest continual daytime uses of bandwidth. All of the work that used to occur between employees and the corporate server inside of the business is now going to traverse the Internet.

I’m sure network engineers everywhere are keeping an eye on the changing traffic, particularly to the amount of broadband used during the busy hour. There are a few ways that the busy hour impacts an ISP. First, they must buy enough bandwidth to the Internet to accommodate everybody. It’s typical to buy at least 15% to 20% more bandwidth than is expected for the busy hour. If the size of the busy hour shoots higher, network engineers are going to have to quickly buy a larger pipe to the Internet, or else customer performance will suffer.

Network engineers also keep a close eye on their network utilization. For example, most networks operate with some rule of thumb, such as it’s time to upgrade electronics when any part of the network hits some pre-determined threshold like 85% utilization. These rules of thumb have been developed over the years as warning signs to provide time to make upgrades.

The explosion of traffic due to the coronavirus, might shoot many networks past these warning signs and networks start experiencing chokepoints that weren’t anticipated just a few weeks earlier. Most networks have numerous possible chokepoints – and each is monitored. For example, there is usually a chokepoint going into neighborhoods. There are often chokepoints on fiber rings. There might be chokepoints on switch and router capacity at the network hub. There can be the chokepoint on the data pipe going to the world. If any one part of the network gets overly busy, then network performance can degrade quickly.

What is scariest for network engineers is that traffic from the reaction to the coronavirus is being layered on top of networks that already have been experiencing steady growth. Most of my clients have been seeing year-over-year traffic volumes increases of 20% to 30%. If Verizon’s experience in indicative of what we’ll all see, then networks will see a year’s typical growth happen in just weeks. We’ve never experienced anything like this, and I’m guessing there aren’t a lot of network engineers who are sleeping well this week.

Bad Customer Service as a Profit Center

There was a December article in Fast Company that spelled out what I’ve long suspected – that many big companies have lousy customer service on purpose – they want to make it hard for customers to get refunds or to drop service. The article was written by Anthony Dukes of USC and Yi Zhu of the University of Minnesota. The article is worth reading if you have the time to click through all of the links, which elaborate numerous ways that big companies abuse their customers.

This certainly rings true for the big ISPs. I harken back to the days of AOL, which was famous for making it a challenge to drop their service. Comcast has always had a reputation of making it hard for customers to break a bundle or leave the company for another ISP.

The article cites some interesting statistics. They claim that in 2013 that a study showed that the average home spent 13 hours per year disputing charges with customer service. That’s nearly two workdays of time, and it’s little wonder that people hate to call customer service.

Customer service at the big telcos and cable companies was never great, but in my time in the industry it’s gotten worse – the big ISPs are now rated at the bottom for customer satisfaction among all corporations. I think the big change in the industry came in the last few decades when the big ISPs got enamored with win-back programs – offering customers incentives to stop them from dropping service. Unfortunately, the ISPs tied employee compensation to the percentage of win-backs and there have been numerous articles published of ISP employees who would not let somebody drop service and who would keep a customer on the phone for an hour to convince them not to leave.

ISP customer service also took a downward spin when every call with a customer turned into a sales call trying to sell more services. Unfortunately, these sales efforts seem to result in new revenues, but it’s irksome to customers to have to listen to several sales pitches to accomplish some simple customer service task.

Dukes and Zhu claim that a lot of customer service centers are structured to dissuade customers from dropping service. They say that long hold times are on purpose to get customers to give up. They cite some customer service centers where the people answering the first call from customers have no authority to change a customer’s billing – only customers willing to fight through to talk to a supervisor have a chance at fixing a billing problem. They claim that chatbots are often set up in the same way – they can sound helpful, but they often can’t make any changes.

They also believe that companies are getting sophisticated and use different tactics for different customers. Studies have shown that women get annoyed faster than men in dealing with poor customer service. Research has shown that some demographics, like the elderly, are easier to dissuade from getting a refund.

Smaller ISPs understand the poor customer service from the big ISPs and most of them strive to do better. However, I know of smaller ISPs with aggressive win-back programs or who use every call as a marketing opportunity, and such ISPs have to be careful to not fall into the same bad habits as the big ISPs.

I find it amusing that one of the many reasons cited for breaking up the Bell System was to improve customer service. Regulators thought that smaller regional companies would be nimbler and do a better job of interacting with customers. This turned out not to be true. In fact, I consider my interactions with monopolies to be the easiest. I can’t recall a call I’ve ever had with an electric or water utility that wasn’t completed quickly and efficiently. Perhaps ISPs ought to strive to be more like them.

Is it Time to Sell?

A lot of ISPs hope to someday cash in on their sweat equity by selling the business. There have been some surprisingly high recent valuations in parts of the industry which raises the question if this is a good time to sell an ISP?

Anybody that has considered selling in the last decade years knows that valuation multiples have been stagnant and somewhat low by historic standards. A lot of properties have changed hands during that time with multiples in the range of 4.5 to 6.5 times EBITDA (earnings before interest, taxes, depreciation, and amortization). Some ISP properties have sold outside of that range based upon the unique factors of a given sale.

In November, Jeff Johnston of CoBank posted a long blog talking about how valuations might be on the rise – particularly for companies with a lot of fiber or with other upsides. He pointed to three transactions that had valuations higher than historic multiples for the sector.

  • Zayo sold their network of 130,000 route miles of fiber transport for a multiple of 11.1 times EBITDA.
  • Bluebird Network in Missouri and nearby states sold a 6.500-mile fiber transport network for a multiple of 10.4 times EBITDA.
  • Fidelity Communications of Missouri sold an ISP with nearly 135,000 customers for a multiple of 11.7 times EBITDA.

Johnston doesn’t say that these high multiples are the new standard for other ISPs. However, he does surmise that the high multiples probably indicate an uptick in valuation for the whole sector. That’s something that’s only proven over time by seeing higher valuations coming from multiple and smaller transactions – but the cited transactions raise the possibility that we’re seeing an increase in valuation for fiber-based businesses.

It’s important to ask why any buyer would pay 10 or 11 times EBITDA. A buyer paying that much will take a decade to recoup their investment if the purchased business continues to perform at historic levels. Nobody would pay that much for a business unless they expect the margins of the acquired business to improve after acquisition – that’s the key to higher valuations. The buyers of these three businesses are likely expecting significant upsides from the purchased properties.

Buyers often see a one-time bump in margin from the increased efficiency of adding an acquisition to their existing business. This is often referred to as an economy of scale improvement – overheads generally become more affordable as a business gets larger. However, buyers rarely will reward a seller for the economy of scale improvements, so this is rarely built into valuation multiples.

A buyer is usually only willing to pay a high multiple if they foresee the possibility of significant growth from the purchased entity. The purchased company needs to be operating in a footprint with upside potential, or else the purchased company needs to demonstrate that they know how to grow. A buyer must believe they can grow the acquired business enough to recoup their purchase price and also make a good return. For a fiber ISP to get a high valuation they have to be able to convince a buyer that the business has huge upside potential. An ISP needs to already be growing and they need to be able to demonstrate that the growth can be ongoing into the future.

One of the more interesting aspects of getting a high valuation multiple is that a buyer might expect the core management team to remain intact after a sale. That often means that part of the compensation from the sale might be incentive-based and paid in the future based upon post-sale performance.

To summarize, an ISP can get a higher valuation if they can convince a buyer that there is future upside to the business. ISPs that don’t have growth potential will not see the higher valuation multiples cited above – although many potential sellers will think these multiples apply to them. The bottom line is that if your ISP is growing and can keep growing, and you can paint that picture to a buyer, your business might be worth more than you expected.