A New Model for Open Access?

Fiber CableThe traditional open access business model to serve residential customers has never worked in this country. I am familiar with the financial performance of most of the existing open access networks and from a purely financial perspective they are all failures. A few networks have failed outright like Provo. A few others have been able to generate enough revenues to cover annual operating costs, but most don’t even do that. And from what I’ve seen, none of the existing open access networks have ever been able to generate enough cash to pay anything towards the cost of building the fiber network, leaving the cities that build the network holding the financial bag for the initial investment.

There are a few reasons that this has never worked. First is that open access naturally drives ISPs towards cherry picking. Open access networks operate by charging fees to ISPs to use the network. If an ISP pays the typical $30 per month fee to use the network, they are not going to sell inexpensive broadband to anybody in the community. So when ISPs only sell high-priced products they don’t get enough customers and the city network owner doesn’t collect enough revenue to pay for the network. This has happened to every traditional open access network. None of them have signed up enough customers to pay for the networks and everyone who has built a network using this model ends up heavily subsidizing the open access network.

The other issue is that most cities have had trouble attracting very many quality ISPs. The whole concept of open access is to offer choices to customers. But most of the open access networks in the country only have a few ISPs, and even the ones they attract are often tiny, undercapitalized businesses. Attracting ISPs is so hard that there is one large open access network today that has been reduced over time to having only one residential ISP on the network. That’s not providing much customer choice.

But there are two cities looking at an alternative model. One is the small city of Ammon, Idaho, and the other is San Francisco. Both cities want residents to pay for the basic cost of the network. It’s an interesting idea.

In Ammon a household that wants broadband access will pay a tax levy of $10 to $15 per month and will also pay a utility fee of $16.50 per month. This means that each subscriber will pay $26 to $31 per month for the fiber network – a very similar charge to what is charged to ISPs on other open access networks. The Ammon commitment is voluntary and only those that sign up for broadband will pay the fees.

San Francisco is considering a similar proposal. There, residents would pay a monthly utility fee of $25 and businesses would pay as much as $115. In San Francisco this fee would be mandatory and everybody in the City would be assessed the fee. In an NFL city the fee probably has to be mandatory to assure that the network will be paid for.

Having customers pay a fee to the city takes the pressure off the cherry picking issue. By lowering what ISPs pay there is a lot better chance of having affordable products on the network. And that ought to result in more customers on the network.

But like any idea this one still leaves some open questions. For instance, how does the city make enough money over time to pay for the inevitable replacement of electronics or catastrophic events like storm damage? Or what does a city do if the ISPs don’t do a good job and customers don’t like them? The Ammon plan requires the payment of fees for a very long time, and small businesses like ISPs often don’t have the staying power to last for a long time. How will the business keep up with inflation – will the fees have to increase every year? And what happens if the city doesn’t get or keep enough customers to pay for this – will the fees go up for everybody else or will the city subsidize the network?

In a voluntary system like Ammon I also wonder what the consequences are for homes that change their mind over time. What if somebody has a financial problem and is unable to pay the fees? What happens when they want to sell their home – is this fee a tax lien of sorts? That’s what has happened to homes that buy solar power systems that are paid for over time. And what happens if a new buyer doesn’t want the fiber and doesn’t want to pay the fee? No doubt over time there will be legal issues to figure out.

The challenge to make this work in San Francisco seems much more difficult. It’s not hard to envision lawsuits from citizens who don’t want to pay the fees. And I can imagine a fierce battle with Comcast and the other current ISPs over the legality of a mandatory fiber utility fee. This seems like a concept that could take a decade of court time to resolve.

But the idea of having citizens somehow pay for the fiber network is an interesting one. Irrevocable customer pledges are a revenue stream that can be used to finance fiber construction. It’s hard to know if this concept will work until we see it in action. But it shows how serious cities are becoming to get good broadband. One has to think that if households are willing to sign long-term pledges to pay for fiber that it has to make a difference. I am sure communities all over the country will be watching to see if this works.

Why Aren’t There More Fiber Overbuilders?

Fiber CableThere are cities everywhere hoping for somebody to build fiber in their communities. I see cities surprised all the time when they can’t find anybody interested in building fiber. I think cities and people in general greatly overestimate the ability of private companies to fund and build fiber. So why aren’t there more fiber overbuilders?

First, there are hundreds of companies that are building fiber, but most are relatively tiny. There are independent telephone companies, cable companies and ISPs that are building fiber in their local markets. But every small company has a natural debt ceiling that restricts their ability to raise money, similar to a limit on how much money a family can borrow. As these small companies borrow money to build fiber they can quickly max out their ability to borrow more money. I have talked to dozens of small companies who have already built some fiber and that would like to build more – but once they get to a certain level of debt on their balance sheet lenders won’t extend them more credit.

Borrowing also requires cash equity. It is not unusual for a lender to want to see 10% to 20% of a project funded by equity before they will lend. Even a fairly modest fiber project can cost $30 million or more and that means that a builder would need $3 million to $6 million in cash equity to fund such a project. I don’t think most people realize that small companies rarely sit on that kind of cash. And even if they do, once they use their cash reserves for a project or two they are unable to finance additional projects.

Fiber business plans are also hard to finance because they lose money for the first few years before they generate any cash. That is a real challenge because during the first few years the builder has to not only cover operational losses, but they also normally have to begin making debt payments before they have generated enough cash to cover those payments. This then forces them borrow to cover debt payments – something that is hard to make work. I have seen numerous fiber business plans that cannot be funded because there is no easy way for the borrower to make it through the first three or four years. Many of these projects would eventually become great cash generators, but nobody is willing to take on a project that will run out of cash before getting to that better future.

Probably the biggest problem for small fiber builders is that there are not very many good sources of commercial debt for fiber builders. There was a time in this country when infrastructure construction was funded by the big banks. But those institutions – for a number of reasons – have largely bailed on funding almost all kinds of infrastructure. This affects not just fiber projects, but also roads, bridges, electric grids, water systems and infrastructure of all kinds.

There are a few sources for funding fiber projects, but the funding available represents only a small fraction of the demand that the public has for fiber projects. If every penny of funding that is available for fiber was to be borrowed the country would still largely be without fiber. There are not enough lenders willing to make the cash available to fund the national need. And this means that builders must be very selective and only put their money where they can make the best returns.

Interestingly, it’s now easier to fund rural fiber projects than it is to fund projects in larger towns (larger being towns over 20,000 population). There are a number of federal loan guarantee programs and other financing tools like new market tax credits that can help with rural projects that are not available to support fiber in larger communities. It’s certainly an interesting financial market that will fund fiber to farms before funding fiber to whole cities.

The best returns on fiber are made from what I call cherry picking. This is when a fiber builder only builds to business districts or to a few key parts of a city. Building very selectively where the returns are the best is probably the best use of the limited capital that a builder has available.

A lot of cities don’t understand the economics and want to impose a lot of restrictions on fiber builders. They want a builder to serve the whole city quickly; they want them to offer low-priced broadband to solve the digital divide and they even want them to finance a network and then open it up as an open access network for other carriers to use. The handful of fiber builders can be very selective and will shy away from markets that make these kinds of demands. Cities don’t seem to understand that in a world with very few fiber builders that those builders get to call all of the shots.

New Life for Open Access Networks?

CoH_City_seal_BlueGoogle Fiber and Huntsville Alabama just announced an interesting public private partnership. This is something that’s new for Google. In this partnership Huntsville is going to build and own the network and Google will lease connections on the network. Other ISPs will also be able to get on the network making this an open access network.

The details of the arrangement were not announced but there have already been a couple of interested parties that have made public records requests about the deal, so we ought to know more soon about how it will work.

There are a number of different ways to operate an open access network. For instance, a city can only own the fiber network and leave it up to ISPs to install the needed fiber drops and the customer electronics. At the other extreme a city could pay for everything. Since it’s been widely reported that Google uses some proprietary electronics my guess is that Google will be responsible for the electronics and the city for the rest. But we’ll have to wait a bit to see those details.

If Google does utilize a custom set of electronics it will be interesting to see how the city proposes to handle adding other ISPs to the networks. There are a lot of networks that would have a hard time handling different kinds of electronics mixed everywhere throughout the network.

The real question that everybody is going to want to know is if the city can make enough revenue from this arrangement to pay for the network. I’ve modeled open access networks many times and about the only way I can see for the network owner to break even with open access is if there are a lot of customers using the network.

And that is the biggest dilemma for owning an open access work. The big open access networks in Europe have a very high overall penetration rate because there are literally a dozen quality ISPs that compete on each network – basically multiple Googles. But if customer penetration rates fall below 50% it gets harder to see a path towards profitability for the network owner.

Fairly simple math can be used to demonstrate the dilemma for open access. If the network has a high penetration rate, say 70% or higher like happens in Europe, then the network owner can charge a relatively small fee per connection and can still break even. But should that same network have a small penetration, say 30% or 40%, the network owner would have to charge twice as much per connection to recover their costs.

The dilemma for network owners is that charging a high connection rate naturally leads the ISPs to cherry pick – that is, not sign up customers with low revenues that don’t create a good enough margin over and above the cost of the network connection. To give an example of this, if a network has a connection charge of $15 per customer, then some ISP in the market is probably going to be willing to use that connection to sell relatively low-price broadband, perhaps at $35 to $40 per month. But if the connection charge is instead $30 per customer, then no ISP is likely to chase those same $40 customer revenue opportunities and will only pursue customers willing to pay more.

This puts network owners in an economic bind. If they charge a low rate but don’t get a lot of customers they don’t make enough revenue to recover their costs. But if they raise the connection charge they force the ISPs to cherry pick and only sell more expensive products, and the network owner still might not sell enough connections to break even. The higher the connection charge, the fewer the potential connection that can be sold. It’s an interesting economic dynamic and one that puts all of the risk on the network owner.

I’m sure the deal is good for Google or they wouldn’t have signed it. It certainly relieves Google of a huge capital outlay. What others cities are going to be most interested in is if this a good deal for Huntsville. Most of the open access networks in the country have not done well for the network owner and it will be interesting to see if having a premiere tenant like Google will make a difference in the open access dynamic.

The Big City Bandwidth Dilemma

Seattle-SkylineSeattle is like many large cities and they badly want a gigabit fiber network everywhere. They were one of the earliest cities to want this and they hired me back in 2005 to try to find a way to bring big bandwidth to the city. They still don’t have fiber, and they recently commissioned another study to see if there is a solution available today.

The study concentrated on the cost of bringing fiber everywhere and about how the City might be able to pay for it. After all, no city wants to build fiber if they don’t reasonably believe they can make the payments on the bonds used to pay for the fiber. The report shows that it’s very hard for a large City to justify paying for a fiber network. And this highlights what I call the big city bandwidth dilemma. Should a City just wait to see what the incumbents do and hope that they eventually get gigabit broadband, or should they be like Seattle and keep pushing for a solution? There are two major aspects of the dilemma that every city is wrangling with:

The Incumbent Response. If a city does nothing they may never get fiber, or they might get fiber to some of the ‘best’ neighborhoods, but not everywhere. We see that in markets where somebody other than the incumbents brings fiber that the incumbents immediately step up their game and offer fast speeds. There is no better evidence for this than in Austin where both AT&T and Time Warner quickly announced much faster speeds and competitive prices to offset Google’s entry into the market.

But everybody understands that the incumbents in Austin would not have increased speeds absent any competition, as can be seen in their many other markets. This create a huge dilemma for a city. Should they decide to build fiber alone or with a commercial partner, that new venture will be met with stiff competition and will have a hard time getting the needed market penetration rate to ensure financial success. But should the city do nothing – then they get nothing.

Citywide Coverage. In large cities almost no commercial builder is willing to build fiber to every neighborhood. One doesn’t need a crystal ball to look at the consequences of this in the future. A city will become a patchwork of fiber haves and have-nots. The have-not neighborhoods probably already have some poverty and blight, but if they get walled off from having the same broadband as everybody else, then over time they are going to become even more isolated and poor. Every city that has Google coming to town is so thrilled to have them that nobody is looking forward ten and twenty years to imagine what will happen to the neighborhoods without fiber.

Cherry Picking. Google is selling a gigabit for a flat $70 per month. While that might be cheap for a gigabit it is still a cherry picking price that is too expensive for most households. It’s hard to imagine more than 30% to 40% of any market being willing to pay that much for broadband. A large number of homes settle for something slower, but that they can afford.

And almost every other gigabit provider charges more than Google. For example, CenturyLink is now selling a gigabit in some markets at $79.95—but in order to get it you have to buy a $45/month phone plan. Before taxes that means it will cost $125 per month to get the gigabit. I can’t see that Comcast has a gigabit product yet, but earlier this year they came out with a 2-gigabit fiber-fed product priced at $300 per month.

The problem with cherry picking is that it also creates a market of haves and have-nots. The incumbent cable company may not like the competition, but they know they are still going to be able to sell over-priced bandwidth to the majority of the market. Look at how Comcast has fared against Verizon FiOS and you will see that, while they hate competition, they still fare quite well in a competitive market.

A Possible Solution? The Seattle report did suggest one solution that could make this work. Cities not only want fiber, but they want fiber everywhere and at prices affordable to the vast majority of their citizens. Any city that can accomplish that understands that they will have a huge competitive advantage over cities without affordable fiber.

The report suggest that Seattle ought to ‘buy-down’ the retail rate on a gigabit by paying for some of the network with property taxes. This is not a new idea and there are a few small cities that have financed fiber using this solution. But nobody has ever tried this in a large city.

The report suggests buying the price of a gigabit down to $45 per month, a figure that is not cherry-picking and that a lot of homes can afford. That kind of price certainly would put a whole different set of competitive pressures on the incumbents. I can imagine them screaming and probably suing a city who tries this. But if this was done through a referendum and people voted for it, almost no court will overturn a vote of the people. I don’t know if this idea can work in a large city, but it’s the first idea I’ve heard that deals with the issues I’ve outlined above.