In the Long Run, Optical Will Matter
August 29, 2008
We welcome commentary and discussion on issues, and the following post is in response to a comment received on my two cents on PAETEC.
In a previous life, I served as the President of Frontier Communications. Frontier Communications was the first locally competitive telecommunications company under special license by the New York State Public Service Commission in 1994. For disclosure, I did leave Frontier long before the “old” Global Crossing acquired Frontier, as the smell was bothersome, and I don’t want my name associated with what that management team was doing to the company. Obviously Global Crossing has risen above their challenges and rebuilt into something much better for customers.
For Frontier I managed the entire gambit of services from T1 to optical. I saw firsthand the real numbers as well as reliability statistics. Just like 14 years ago, as it is today, the best of class in T1-like services, the ILECs, generate gross margins of 40%. Obviously anyone can buy from the ILEC under CA96, as best of class may someday reach 30% GM on low end, copper-based services. On optical services, as AFS has experienced, one derives gross margins of 70% - 80% for optical services, but this is only accomplished by having the wisdom, patience and perseverance in understanding that in the long run, optical is all that will matter.
Thank you for the compliment on our unique market position. But what I can tell you is that it was not by accident and I had many, many, many Wall Street firms back in 1999/2000 telling me that basically a demand-based business model like AFS is not a good idea - we were not raising enough money or moving fast enough. Of course, we know what happened - over supply, over building, shared routes without demand resulting in our industry having its first ever depression. Up until this time, since the phone was invented, every year our industry had grown in revenue and profitability.
In order to achieve 70%-80% gross margins, you have to have the fortitude to base your business on the long run and the costs associated with a high-cost, fixed asset network strategy such as fiber optics. As basic economics teaches us, once you are past the high fixed costs investment, the incremental costs of generating high margin revenue in relative comparison is peanuts. I ascertain that owning a metropolitan network creates a barrier to entry for others, and as of 2008, no one is investing into local network builds on any great scale without demand built-in.
Shoot me an email or add a comment below.
Profitability vs. Manifest Destiny
August 29, 2008
Consider this post an epilogue to the series on forbearance. AFS is a privately held company, and someone coming up with “AFS only hits about 1% of businesses in any market” reflects a limitation in research, not fiber service. It is an incorrect statement in and of itself. Here are some facts…
We did not get trapped in the Wall Street measure of national manifest destiny that so many did, and we did not perish in bankruptcy. CA96 promoted a pro-competition framework … no we don’t look like others and our market segments are different from most others. Actually, only a handful of us as a percentage of all competitors chose to build and own fiber infrastructure methodically and rationally as a sustainable strategic advantage. I believe the count today is less than 30 metro network fiber providers remain; of the 30, only a handful are financially healthy.
Our fiber placement is unique in our markets with primarily one competitor to route compete against with, Ma Bell. We only address the business segment; consumer residential is a two wire game between the cable company and the ILEC. We only connect bandwidth into buildings where the lead-in customer requires a minimum of 50 megabits. We purposely don’t want to be in the low end, copper retail, high churn, no loyalty, thin margin, low price-only, usage sensitive T1, IAD, DSL retail segment. However, we do backhaul for these folks in this segment over our unique network footprint as a viable, diverse, reliable alternative to Ma Bell. And, by the way, once we drop fiber into a building, it does not take long for us to garner 100% building share.
We place our fiber in our markets to address 95% teledensity of high bandwidth, high margin buildings. We maintain a database of physical audits of these buildings inclusive of prospects, digital photos of the telco closet, racks, terminations, GPS coordinates and building entry points for the fiber. We pretty much know what’s going on when our sales person shows up and more importantly, how to price based on the route and competition. 50 megabits, by the way, blows out most copper clad CLECs in a building.
We have been taking one building at a time since inception in 2000 and have a CAGR of 40% for revenue…our margins are to die for. We are not a big top-line revenue testosterone driven company; we only want to address the 20% of the high margin, high bandwidth segments in our markets where we do have a greater market share than 1%. We are a different cat, and given the fiber shortage, we can keep doing what we are doing because like the GAO, lots of buildings still lack another real competitor, let alone fiber access. We prefer profitability to manifest destiny. After all, our customers actually like us, and they recognize we need to stay in business to provide the service they have come to appreciate and trust.
Lack of Competition & Illogical Conclusions
August 28, 2008
We’ve been talking about what is in place relative to the “pro-competitive deregulatory framework” Congress authorized under CA96, including the historical context on forbearance. Here, again, are the four answers I proposed in the last post:
- A near zero cost of entry for competition.
- Complete fall off of innovation.
- Severe lack of true, real broadband facilities competition.
- Illogical conclusions where forbearance on wholesale pricing has been granted and, temporarily, where it has been denied.
I explained the first two points in the last post, “What has CA96 given us?” Now let’s explore the next two answers.
Lack of Facilities Competition. If you want a 90-day business that Wall Street analysts will eventually run from, don’t own fiber. Our present reality is that CA96 did little to promote and rationalize fiber deployment. Yes, we had crazies that built on top of each other or joint built in the largest of cities only to find a route based fiber glut where service prices decline 30% to 50% annually.
What people have difficulty understanding is that revenue growth and margins are route specific, not market specific. However, lazy marketers often price their services not by a network/route advantage but by those prices the renters charge market wide because they work out of Ma Bells copper central offices.
Let me share a story. A few years back, we had a prospective 100-megabit customer pushed to me by sales for assistance. What this prospective customer wanted was the same price for a circuit in Kansas City as they were getting in Columbus Ohio. The prospective customer could not understand why our price was higher. Now, it’s a fact that Columbus has a twenty plus duct system running around it in which everyone and his brother placed fiber. Thus, the route was saturated. If our company sold totally on price and not on the value of the unique routes we provide as a network owner , we would have dropped our drawers like most do to get the sale! Instead, I politely told the prospect if they want that Columbus price, they need to go to Columbus, dig up the fiber and install it in Kansas City. The prospective customer went away for a while in search of options but eventually ordered from us as our fiber route was unique.
Where I believe Congress screwed up was not applying sunset provisions for Ma Bell pieces & parts in CA96 whereby new market, light-asset competitors would realize and rationalize their plans and capital expense. I believe such a sunset provision would also have had a rationalizing effect on local fiber deployment as well which would have incented “gas pipeline” like partnerships and contiguous metro fiber builds. It’s still not too late to sunset pieces & parts renting; such clarity may actually attract new capital for infrastructure investment. Capital investors want clarity.
Illogical Conclusions. Once again, my opinion, but market share measures have little to do with actual competition. The FCC relies on market share data instead of actual competition which is misleading in applying forbearance. I live outside the beltway, so here is a simple question/observation: How do the sparse markets of Omaha, Neb., and Anchorage, Alaska, qualify for wholesale forbearance with literally a handful of competitors, while cities like New York, Boston, Philadelphia, Los Angeles, San Francisco, Dallas, etc., have gobs of competitors of all ilks, and forbearance in these highly competitive cities gets denied/delayed? It is illogical.
Another documented logical conclusion which supports my position on forbearance comes from a November 2006 Federal Government GAO report. The Federal Government Accountability Office (GAO) collected data highly critical of the FCC for a report on competition by actually pulling circuit type data from 16 markets through a proprietary, highly confidential database that Telecordia keeps. This database identifies who has what circuits and where. The GAO report was highly critical of how the FCC measures competition as the GAO released their findings on true, real, physical facility based competition. This November 2006 report stated that 94% of business buildings in the United States have only one true, real, physical facility based provider … Ma Bell. The FCC would identify 5-7 competitors in a building, however, all riding over the same Ma Bell infrastructure including Ma Bell. The report may be found at www.gao.gov/cgi-bin/getrpt?GAO-07-80 . The data supports a need for wholesale forbearance to attract new infrastructure investment. It’s been 12 years since CA96. Should asset-light competitors get another 12-year term to figure out that they should stop relying on Ma Bell? I think not.
Two Cents on Paetec
August 28, 2008
I got an email from a reader that said, “I’m surprised I haven’t seen the Straight Shooter’s $0.02 on this topic: Who will buy McLeod’s fiber from Paetec?”
Here’s my take: What I heard on the conference call is that PAETEC is not selling fiber anymore, so analysts should not rely on said sales going forward.
I think it’s a smart move not enabling competitors. That said, previous management to Paetec, attempting to avoid bankruptcy, sold fiber on the cheap thus enabling low cost competitors on the same local fiber routes. I don’t believe Arunas was saying that they will divest and be a non-fiber participant. If this were the case, in my opinion, Paetec would not have bought McLeod. I believe Paetec management understands that fiber enables greater margin control/growth and service differentiation.
Paetec hit a bump in the road; they should be running to local fiber, not from it, regardless of the 90-day Wall Street view of matters. Local fiber creates a sustainable, competitive advantage.
What has CA96 given us?
August 25, 2008
We’re continuing the series on forbearance. Last time we reviewed the historical context of forbearance.
So the question to be asked, given where we are with forbearance, ingrained telecom company habits, and governmental intervention (or non-intervention depending on your point of view) is “what do we really have in place relative to the ‘pro-competitive deregulatory framework‘ Congress authorized under CA96?” We have four answers.
- A near zero cost of entry for competition.
- Complete fall off of innovation.
- Severe lack of true, real broadband facilities competition.
- Illogical conclusions where forbearance on wholesale pricing has been granted and, temporarily, where it has been denied.
Let’s tackle the first two points:
Zero Cost of Entry. Though reshaped by the courts since CA96, at one time the availability of renting pieces & parts from Ma Bell ranging from UNE-P to copper loops to resale enabled low cost market entry or asset-light entry for thousands of competitors. These competitors, for the most part, went wide rather than deep with their business models — cream skimming. Once it was realized that these asset-light companies each required the same 12 % market share in each city to breakeven, and you had 50 or so asset-light competitors competing … the bankruptcies soon followed. This is not to say that asset-light models didn’t work, there were a few exceptions the most notable up until now has been Paetec Communications and CBeyond Communications.
Innovation. I believe our industry is entering a high growth bandwidth inflection point. We are hearing reports of slowing bandwidth growth and assume that it is due to lack of demand or economic softness. My belief is the 75% of broadband penetration we have reached in the United States is slowing not due to demand but the carrying capacity of legacy copper solutions and lack of real facility competition …we have a fiber shortage my friends.
Since CA96, great lobbying efforts have been made to create a level playing field amongst telecom industry participants, in doing so has totally missed the pro-competitive, de-regulatory framework Congress authorized. If all parties are equal, there is minimal incentive for innovation. I place this akin to a socialist government, where everyone in gray looks good. I can’t find innovation at work over the past 12 years. VPN’s have been around since 1983, IP packets go all the way back to the 1960’s with IBM’s TCP/IP the precursor to the Internet Protocol stack. Voice services have been mass produced since the early 1900’s.
I believe by not having a level playing field, comrades, that innovation will occur much to the disadvantage of Ma Bell. But when everyone shows up looking like, packaging like, offering like and performing like Ma Bell, all we have is a lot of gray.
More to come on the next two points, lack of competition and illogical conclusions.
Historical Context on Forbearance
August 22, 2008
Glad to see that I am striking a chord with people on the issue of forbearance. I’ve received many engaging comments and questions, including the following post from a fellow blogger Peter Radizeski of Rad-Info, that gave me pause to expand on the history and the data surrounding the topic in this next series of posts on forbearance.
…To an extent, I agree. Most CLEC’s still do go after some arbitrage play to make money. (If I hear I will save you money one more time in a marketing session!!!) The whole idea behind TA96 was for CLEC’s to get a footprint started by using Bell facilities, then create their own. (It’s also why spectrum was sold — as facilities replacement).
But I would argue here (heavily) that Dave is wrong about Forbearance. The reason: because the FCC has done such a sloppy job of their job. Flip flopping on everything. If the one goal was an effective third party provider, the FCC would have stayed that course. Spectrum would have gone to companies other than the Bells to be used for a copper replacement.
The FCC could have driven us to a 3-way system by now, if the F Agency had that vision. I don’t think it ever did. Or ever will.
And to jump to forbearance now would destroy our economy in ways that the credit crisis couldn’t.
BTW, Dave, even AFS only hits about 1% of businesses in any market. That’s kind of limiting.
My position on forbearance has less to do with the fact that I am in the metropolitan fiber optic business than with what the CA96 afforded the FCC as a power under the Act, as a “pro-competitive, de-regulatory framework.” That being said, I hope my experience of actually starting, running, and continually growing a successful metro optical fiber business lends some credibility to this article. There’s no substitute for actually being in the trenches.
First, some history… The FCC was never granted the authority to forbear until the CA96 statute granted such authority. Prior to the act, the FCC made many attempts to forbear on telecom regulatory issues with the only consistent result since CA34 being courts of law denying the FCC of this authority . Congress, in their infinite wisdom to only be found inside the beltway, granted certain forbearance authority to the FCC under the CA96 for a “pro-competitive, de-regulatory framework.”
For the most part historically, most other federal regulatory bodies have never been granted a statute to forbear, and the few that have are substantially limited in said authority. Under CA96, as we have experienced, Congress erred in not placing better definitions or boundaries on the FCC relative to forbearance. As a result, the FCC concluded they had cart-blanche authority in wielding the power of forbearance as an inherent authority. As we all know, the ILECs have taken the FCC to court many times over issues related to their inherent authority of forbearance with the courts — the vast majority of the time — agreeing with the ILECs. Bottom line: the United States Congress and their lobbyists failed to place adequate definition of purpose, construct and applicability of forbearance authority, and our courts are shaping the issue.
Given the historical context and winnowing down of FCC forbearance authority by the courts, my position remains the same on forbearance — releasing the ILECs from competitive restraints is necessary for economic global competitiveness and to align with the framework as established by CA96. Moreover, market competition which is unimpeded will result in investment into new infrastructure. Contrary to some beliefs, telecom is not a dot-com business; the winners always have and always will own network infrastructure. And when I talk about network infrastructure I mean a network that is owned, not virtual or rented — hard fixed assets.
Stay tuned… lots more to come on this issue.
Congrats to the AFS Team
August 21, 2008
Some companies pay lip service to the Golden Rule — but I believe it’s vital to long-term success. Whoever said “nice guys finish last” wasn’t talking about us — we’ve just been recognized by Inc. Magazine, and it’s in large part because of our amazing team and the dedication they bring to our customers each and every day.
American Fiber Systems (AFS), the company of which I am honored to be the Chief Executive, was named to the Inc. 5000 list of fastest growing companies. We ranked #622 overall and a whopping 21st among telecommunications companies. I can’t say thank you enough to our entire team, because each had a hand creating positive customer interactions and generating remarkable customer loyalty which has fueled our growth. To this day, AFS has one of the lowest attrition rates in telecom.
Telecom has had its share of companies willing to sacrifice the customer experience and service level for its own financial benefit. That’s a big part of the reason for starting AFS — so we could do business the right way and still be profitable. The two do not have to be mutually exclusive, and the AFS team proves that every day.
Congrats to the other telcos mentioned on the list. It’s a great time to be in this space, and we’re excited about what the future holds.
Comment Response: Just how prevalent is Ma Bell?
August 13, 2008
The following comment was posted on the 8×8, Inc., Yahoo! Message Board late last evening citing one of my previous posts:
“90% of business buildings are still served by one providers infrastructure, that being Ma Bell. ”
http://www.telecomstraightshooter.com/20…
Still not sure I believe it. Comcast has spent plenty of money marketing to enterprise customers in my area. They must have sufficient cable in the right commercial zones.
Still, this is what Martin (CEO of 8×8, Inc.) has been telling stockholders, believe it or don’t.
See the comment posted on the 8×8, Inc., Yahoo! Message Board
My response: I believe in data … real data. The FCC collects data on competition by an honor system. The Federal Government Accountability Office (GAO) collected data for a report on competition by actually pulling circuit type data from 16 markets through a proprietary, highly confidential database that Telecordia keeps. This database identifies who has what circuits and where.
The GAO report was highly critical of how the FCC measures competition, as they released their findings on true, real, physical facility based competition. This November 2006 report stated that 94% of business buildings in the United States have only one true, real, physical facility based provider … Ma Bell. The FCC would identify 5-7 competitors in a building, however, all riding over the same Ma Bell infrastructure including Ma Bell.
The report may be found at the following location: www.gao.gov/cgi-bin/getrpt?GAO-07-80
Sustaining Power — Metro Fiber
August 12, 2008
It’s about one hour before the tw telecom analyst call, and I can’t wait. Larissa Herda (tw telecom CEO) and friends have hit a home run at a time others are pointing at the “soft” economy as an excuse for not performing. tw telecom’s results and especially margin growth are consistent with owning and operating from your own local fiber optic platform.
If you have read this blog before, I openly admit I am a metropolitan fiber optic bigot. No shame in that. I came out of the telephone closet on this years ago.
tw telecom has done what few of us had set out to do. They have executed a long term strategy to sustain their business. That strategy, pooped on quite often by Wall Street over the years, was to build, own and operate their own metropolitan fiber optic infrastructure. And much to holding steady to this strategy, the proverbial rooster is coming home to roost while others not fiber-fortunate get squeezed by falling prices, Ma Bell renting costs and copper capacity being outstripped by physics for optical connectivity demand applications.
Besides the control you get over your costs and the unlimited bandwidth of optical access which are apparent in tw telecom’s results, you also get a certain level of regulatory immunity. This is true because the fiber is a by-pass mechanism of Ma Bell’s copper loops and special access end of life legacy network — pieces that others think they must buy!
(Sometime I will write about why I think Ma Bell’s pieces and parts are like having a drug addiction with said addiction locked in by the sole supplier.)
What most of us don’t understand, which gives tw telecom and others likely situated an even greater advantage, is that without a fiber platform you will always be disadvantaged. Customers churn when things don’t work. Customers churn when their experience sucks. Customers churn when inadequate bandwidth is available for a content rich experience (i.e., applications).
Contrary to telecom culture, customers don’t wake up in the morning telecom centric and believe that their life revolves around their provider of connectivity. Yes, as hard as it may be to believe, all the customer wants and needs is a robust, reliable rich experience. They really don’t care about our telecom acronyms either!
Being the metropolitan fiber network bigot that I am, today it’s not about the applications. In the near term, perhaps the next five years, it will be about bandwidth growth outstripping copper, bandwidth reliability and a bandwidth-based robust user experience. In my simple mind, you can have all the gee-whiz applications you want, but if they are not “bandwidth experience” supported and reliable, you might as well as sell pong as an application. (Pong - a primitive TV ping pong game back in the 1970’s which required minimal bandwidth but at its time was the best user experience).
I believe the tw telecom results and some recent inklings from Level 3 are reflecting the beginning a fundamental separation point based on demand from those that rent pieces and parts calling copper a “broadband network” from those that actually can deliver bandwidth over an owner operated local fiber optic facility.
With 90%++ office buildings still being served by one provider - Ma Bell - the bandwidth connectivity upside remains significant. However, such enormous opportunity can only be addressed by a card carrying, network owning, metropolitan fiber optic bigot(s). Don’t put applications ahead of the cart; it’s all about local fiber network location, location, connectivity…
tw telecom’s phenomenal results are solid indications that a new era of bandwidth intensity is just beginning. Those having a tummy ache over the economy … get a dose of fiber in your system and see what happens.
Remember - a clear conscience is the softest pillow.
What a Disappointment
August 8, 2008
The names have been changed to protect the guilty. Read the back story at “Are You Paying for Disappointment?”
Just days ago, our non-ILEC service provider had a major software glitch which inhibited traffic between Washington DC and Atlanta — even on a diverse route. In telecom vernacular, this was a major service affecting outage for anyone on this route.
Because we are 100% IP (a/k/a “convergence”), when these circuits went down, we had zero connectivity and zero productivity company wide.
The disappointment: Our Vice President of IT called this carrier by cell phone to tell them that the outage had us totally disabled, not partially, but totally. The response we received: “Your SLA is for one hour.” This is something I would expect to hear from an ILEC. What a disappointment.
What I can say with 100% certainty, a response like that to an AFS customer by an AFS employee is a career ending response.
The problem we have is that the non-ILEC larger carriers think they are “big” amongst the munchkins when in reality you can add up all their market caps, and they are less than half-the size of Qwest. Or add up their revenues, compare them to 2.87 trillion dollars in global annual telecom revenues or the 1.1 trillion dollar annual USA telecom revenues and these non-ILEC “big” carriers quickly amount to nothing more than a gnat on a rhino’s ass.
There is no need for any non-ILEC to assume the ILEC customer service’s culture and push customers around. They need to have a big slice of humble pie and start thinking about how to beat the ILEC because collectively we all don’t add up to much of anything compared to the big picture. Bad customer service will kill you. Our non-ILEC provider, due to this response, will not get a renewal from us, even if we need to pay more with someone else.
“Your SLA is one hour” — pure disrespect and bullshit.
Remember: The softest pillow is a clear conscience.
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