Can New ISPs Sustain Themselves? Can Telcos?

Revenue, in addition to the cost of the network and other operating costs, is part of the complex  fiber to customer business case. Traditionally, one might have argued that fiber to the home made for tough payback models.

But we now are seeing lots of activity by gigabit Internet access providers that have decidedly different potential economics, driven mostly by the payback model.

For starters, traditional modeling has assumed a mandatory city-wide construction project, and in the U.S. market, at least, a likely ability to convert only about half of all potential sites to the status of “customers.”

Over time, service providers also have moved from a “single service” model to the “triple play,” a change that allows fixed network service providers to build a sustainable model even when only 40 percent to half of sites are “customers.”

The latest innovation is the “build by neighborhood” approach, essentially allowing service providers (ISPs, telcos, cable TV companies) to “cherry pick” their targets, instead of using the older “universal service” approach.

That approach earlier had been used by business-focused service providers (competitive local exchange carriers) to compete for business customers. The basic approach has been to target clusters of customers, using leased access to reach them, and then, over time, deploying backhaul facilities to lower cost.

The new evolution has firms building fiber-rich facilities to neighborhoods where the estimated demand is highest.

The question is long term sustainability, as the price-value relationship is redefined. We might assume investment costs per-location, and potentially, cost per customer, are lower than they were for Verizon Communications.

We might also assume costs are higher than for a new hybrid fiber coax network supporting DOCSIS 3.

That might put the cost per location somewhere between a high of $2,250 per site and $660 per location on the lower end, including activated drops, but not including any required customer premises equipment.

Since none of the new ISPs seem to be using HFC, we can assume their costs are closer to what any other telco would pay for fiber to home network elements. But current prices for telco style fiber to home networks might be far lower than in the past.

The key breakthrough would be if telco style FTTH costs were to approach cable TV HFC costs.

Assume a smaller operator could manage to connect a customer and activate service (including customer premises equipment) for about $300, where a telco connection might cost as much as $800.

Much depends on what services a service provider actually is offering. Internet access will have one cost profile, but video service will add costs.

If the network portion of cost is in the legacy $1450 per passing, then a new contestant might expect to invest $2900 per customer, at 50 percent take rates, plus a connection cost of $300, for a total of $3200.

Against that, assume $70 to $130 of revenue, in some cases. Over a three-year period, that is about $2520 to $4680 in revenue.

Some ISPs, such as Sonic.net, are retailing gigabit connections plus voice for $40 a month, though. That implies three-year revenue of just $1440 per subscriber.

All of that is before operating costs, franchise payments and marketing. Clearly, service providers are counting on longer customer life cycles, incrementally higher revenues and muted operating costs.

Perhaps prices now paid for network elements and cabling are lower than $1450 per passing, though, perhaps in the $900 range per passing. That helps, but does not make for an easy positive business case.

At 50 percent take rates, investment per subscriber at $900 per passing is $1800, plus $300 for connecting and activating a customer, or about $2100.

At 33 percent take rates, costs per customer are about $3000. As always, the business model is highly sensitive to adoption rates.

So a key expectation might be that take rates will be closer to 50 percent than 33 percent.

But the business case still is not easy.

On the other hand, market dynamics might be trending in a direction that makes the gamble less risky.

If one argues the telco business case keeps getting worse, while cable TV holds its own, in many markets, the competition might evolve towards a “cable TV versus independent ISP” model, with telcos becoming weaker competitors.

There is only so much a telco can do to reduce costs, given dividend payout obligations and union workforces, plus pension obligations.

Ultimately, there will be growing questions about sustainability, the possibility of bankruptcies or other restructurings, with the possibility that new sets of owners might be able to create a more sustainable business model. As crazy as that now seems, it cannot be excluded as an eventual outcome.
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