Subsidized Interest Rates

The recent increase in interest rates suddenly makes it more attractive to pursue subsidized government interest rates to build broadband. Meeting debt payments is one of the primary hurdles to launching a successful broadband expansion.

We’ve been lucky over the last decade that interest rates have remained historically low. At a few points, the Federal Reserve rate almost got to zero. In a cycle that I’ve seen many times during my career, businesses get so used to low interest rates that they begin believing that interest rates will stay low forever.

But historically, interest rates have risen and dropped in response to changes in the economy. Over the last decade, the federal government made the deliberate decision to keep interest rates lower than where the market would have normally taken them.

But this year, the reemergence of inflation has forced the Federal Reserve to raise its core federal funds rate several times, and it’s up to 2.5% after starting this year at around 0.25%. There are strong indications that the rate might be raised more, although some of the inflationary pressure is starting to ease. The Federal Reserve rate is important because it is the rate at which large banks borrow from the government, and so increases in the Federal Reserve rate translate instantly into higher bank loan rates and ultimately into higher municipal bond rates.

Suddenly, federally subsidized interest rates look attractive again. The primary federally subsidized interest rate for broadband comes from the Rural Utility Service (RUS) which is part of the USDA. The RUS has always had the ability to offer low-interest-rate loans for projects that hit its target profile of bringing broadband infrastructure to rural locations. The agency currently has several billion in available loans at its disposal.

There are a few other federal programs that can offer lower rates through loan guarantees. In these situations, a borrower works with a bank, and the loan repayments are guaranteed by a federal agency, which generally translates into a lower interest rate. The HUD 108 program can guarantee loans that are used to build infrastructure in areas with lower-than-average incomes. The SBA 504 Loan Program can guarantee loans to start-up businesses, with half of the loan coming from a bank and half loaned or guaranteed by the SBA. The USDA Business and Industry Guaranteed Loans (B&I) can be used to subsidize loans that spur economic development.

Many ISPs don’t like using federal loans for a number of reasons. Applying for federal loans requires a lot of paperwork and cost to prepare, and the loan approval process is not quick. Federal loans often come with harsher requirements for borrower surety, meaning a borrower often has to pledge the entire business to get the loan. Government loans often don’t mix well with other kinds of financing since the federal loan generally requires first priority for repayment. Federal loans sometimes restrict dividends from the loan project until the loan is retired. Finally, federal loans require more reporting.

But even with all of these restrictions, the lower interest rates start to look attractive when a project doesn’t pencil in at normal bank interest rates. An RUS loan at 2% might be worth all of the extra hassle if market interest rates are 5% or 6%.

I know many ISPs who purposefully weaned themselves from federal loans over the last decade to avoid the extra work and inconvenience. This was relatively painless when there wasn’t a big difference between bank rates and the interest rates offered by federal programs.

We have no way to know if today’s higher interest rates are a temporary blip or if interest rates will stay high and return to the traditional up-and-down fluctuation that has been more historically normal. One of the bets you’re making when you pursue a federal loan is that rates will stay high and that the benefits of the lower rates will provide a long-term advantage. ISPs all over the country are likely doing the math to consider the options, and I’m sure that in many of these deliberations that federal loans are back on the table.

The Work Force is Changing

McKinsey & Company recently published an article that explores the changes in the U.S. workforce. The bottom line of the article is that the pandemic gave people time to contemplate their personal and work lives, and a large percentage of Americans have decided to not go back to the kinds of jobs they held before the pandemic. McKinsey is calling this the Great Attrition, where millions of people have decided to retire early, take sabbaticals, start their own businesses, or start a new career.

This is reflected in a lot of statistics. There were a record 11.3 million jobs open at the end of May. After a huge number of people quitting their jobs in 2021, the percentage of people still quitting jobs is up 25% over historical trends.

McKinsey says that the current labor shortage is mostly for jobs that can be classified as traditional. People who are willing to take traditional jobs do so for the benefits, job titles, and the chance of long-term career advancement. The article postulates that the number of people willing to take traditional jobs that put the company first is dwindling. McKinsey doesn’t see that many big companies are changing the way they are recruiting – and this means there is a disconnect between what companies and potential employees are looking for.

Companies are mostly filling traditional jobs by luring people away from other companies, which is resulting in wage inflation but is not addressing the overall underlying number of people willing to take jobs they think will be unfulfilling.

McKinsey suggests that the long-term solution for companies to fill open jobs is to find a way to attract the 40% of workers that McKinsey classifies as non-traditionalists. That’s going to mean a big shift in the way that many businesses operate. Consider the following chart from the article that explains the difference between traditional and non-traditional workers.

The first column represents people who quit jobs between April 2021 and April 2022 but then took another traditional job. These folks look like traditional workers in that career development and advancement, adequate compensation, and meaningful work top the reasons why they took the new job. For the most part, these folks moved on to a company that offered them a better chance for career advancement. The one difference between this list and a list from five years ago is that even traditional workers now highly value workplace flexibility.

The second column represents the factors that non-traditionalists say might lure them to accept a traditional job. Topping the list as the most important reason is workplace flexibility, followed by good pay and meaningful work. The chance for career development and advancement is listed seventh for the reason to consider a job, below having a safe work environment.

The conclusion that can be drawn from this chart and the rest of the article is that building a long-term career at one company is no longer important to many people. People who are looking for long-term advancement will tolerate a work environment with an annoying boss or long hours if they think it puts them on the path toward advancement. But the growing number of people who view jobs untraditionally will likely bail on a company that doesn’t have a great work environment.

This is an important issue in our industry since telcos, cable companies, and other ISPs tend to offer traditional jobs with set work hours, decent wages, and okay benefits. At least historically, ISPs have not been known as places with a flexible work environment. Technicians and customer service reps work set hours. The business office is open at set times. Career advancement is possible, but it’s often a slow path that rewards staying with a company for many years until the bosses above retire.

The article suggests a number of different strategies that companies are starting to consider for filling open positions. One is to reach out to people who retired from a company to see if they can be lured back to work. Companies are looking for ways to become more flexible by allowing people to work from home or periodically take extended vacations.

One thing is for sure; this genie is not going back into the bottle any time soon. In an economy with more job openings than people to fill them, workers are currently in the driver’s seat. And unfortunately for many companies, that means they are not taking traditional jobs.

How Safe is Your Fiber Network?

There was a major attack launched against long-haul fiber networks outside of Paris, France on April 27 of this year. It appears that there was a coordinated attack by vandals to simultaneously cut three long-haul fiber routes. Fibers were cut with what seemed like a circular saw, and sections of fiber were removed to make it hard to make repairs. These were backbone fibers that were shared by multiple ISPs. A few ISPs lost service, and broadband access for almost everybody in Paris was slowed for a while.

The cuts were made at night, and in all three cases, the fiber was buried. There have been no arrests made, and no group ever claimed responsibility for the fiber cuts. But it’s obvious that whoever did this knew of the locations and purpose of the fibers.

There has been an uptick in attacks against communications infrastructure in France. In December 2021 the new outlet Reporterre documented more than 140 attacks in France against 5G equipment and related infrastructure during the year. This includes cutting cables, setting fire to cell towers, and even attacking telecom technicians. Attacks have decreased since the peak in 2020

The last major well-known attack on broadband infrastructure in the U.S. came on Christmas 2020 when a man blew up an RV parked outside of an AT&T switching center in Nashville. This seems to have been a case of mental illness, and police have never determined any motive or reason that AT&T was the target. The Department of Homeland Security issued an alert in the U.S. in May 2020 warning against likely attacks against cellular towers, related to 5G. There have been similar attacks in the UK and across Europe.

Regulators in the U.S. don’t widely publicize outages caused by vandalism, probably to not encourage copycats. In Docket FCC 21-99, the proposed rulemaking to improve network resiliency, the FCC noted the frequency of vandalism against U.S. networks. Carriers have always been required to disclose what the FCC defines as major outages, and the FCC noted that the year with the most attacks was 2016, with 1,079 reported acts of outages caused by vandalism. These attacks come in many forms, including gunshots, fires, and cable cuts.

ISPs are at a loss on how to protect infrastructure any better than it’s already protected. Most vital middle-mile fiber routes are buried, with the location of the routes not highly publicized. We put security fences and security cameras at cell tower sites and communication huts and buildings. But much of our vital infrastructure is located in remote locations – often on purpose. Nobody wants cellular towers or communication huts in residential neighborhoods, so carriers find out-of-the-way places to hide the infrastructure.

This is a warning for anybody building a new network to pay attention to physical security. In driving around, I see a lot of communication huts and cabinets sitting alongside the highway in plain sight. There are a few basics of physical security that every carrier should bake into the plans for a new network.

First, protect the perimeter around facilities. Put buildings and devices behind fences. Plant shrubs to keep infrastructure out of sight. Make it hard to park too near your facilities. And monitor your sites. Modern high definition or 4K cameras can capture the details needed to identify intruders. Cameras are now inexpensive and easy to connect where there is fiber. Connecting cameras to motion detectors can trigger recordings or security alerts when somebody is close to a facility. Consider a camera that includes license plate recognition software.

Planning for Churn

One of the factors that need to be considered in any business plan or forecast is churn – which is when customers drop service. I often see ISPs build business plans that don’t acknowledge churn, which can be a costly oversight.

There is a maxim among last-mile fiber networks that nobody ever leaves fiber to go back to a cable company network. That’s not entirely true, but it’s a recognition that churn tends to be lower on a last-mile fiber network than with other technologies. But customers leave fiber networks. Customers might die or move away. Customers might hit hard economic times and be unable to afford the connection.

I wrote a recent blog that asked if broadband is recession-proof. That was really asking if customers drop broadband when they lose jobs or see household income drop. The reality is that some folks have no choice but to drop fiber if things get tough enough. I’ve read several recent articles talking about how inflation in rents is likely to drive a few million people to become homeless – that might mean moving in with somebody else or becoming truly homeless, and broadband goes with everything else in these circumstances.

Churn varies a lot by community, and an ISP considering a new market should research the relocation rate. About 9.8% of all households move every year, or just over 15 million households. The percentage of people who move annually has declined steadily since the 1960s, when the rate was twice the current level. Renters move a lot more often than homeowners – In recent years, almost 22% of renters relocate each year compared to 5.5% of homeowners. ISPs all know that renters don’t only live in homes, and in many communities, a significant percentage of homes are rented. Younger families tend to move a lot more often than older ones. Only about 1% of households move between states each year. About 16% of military families move every year.

Every ISP has customers who die every year. Pre-pandemic, around 2.7 million Americans were dying each year. During the pandemic, in 2020 and 2021, that leaped to around 3.4 million people each year.

Churn can be a big challenge for an ISP. It turns out that most people call to arrange electric, water, and broadband services before they show up in a new community – and in doing so, they most naturally call the incumbents. Somebody new to a town likely won’t know about a smaller or local ISP. Since most people come from communities with little or no competition, they don’t even know it’s possible to use an ISP other than the big incumbents.

Churn can be expensive. There is an obvious loss of revenue when a customer leaves. More insidious is the stranded investment in drops and installation costs that are no longer generating revenue to cover the investment cost. One of the most surprising things that fiber-ISPs often find is that they must continue to spend money on selling and new installations each year just to stand still with the penetration rate.

I’ve seen ISPs with interesting strategies for dealing with churn. I have one ISP client in a college community that hangs out at the university with a booth and a sign that says gigabit internet. College students know what that means, and the ISP has been successful in maintaining a good penetration in off-campus housing. I have clients who pay commissions to real estate agents who refer new homeowners to them. It’s fairly routine to have arrangements with landlords and rental agents to have them get the word out about a broadband alternative to the incumbents.

Churn is one of the details of operating an ISPs that many new ISPs don’t get for a while. But it’s vital to have a strategy. It’s far cheaper to somehow catch a new customer when they move to town. It’s far less costly to catch the new tenant moving into a building that always has a drop.

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.