Broadband (and maybe wireless) could be the future for small telcos

Broadband and wireless services will be critical to future growth and profitability for small telcos--and the 2010 Telergee Alliance Benchmarking Study underscores that important reality, as well as some of the challenges involved in growing those business lines.

As we’ve noted previously, the Telergee study is conducted annually by a group of accounting firms with a small telco specialty and provides a comprehensive look at small telco financial issues. The researchers were kind enough to share their most recent results with me, and those results provide real-world evidence of why several policy issues are so important to small telcos. Last week we looked at the role of rate of return regulation. This week, we look at broadband and wireless issues.

Broadband is the future

One message that comes through loud and clear from the Telergee study is that broadband is the future.

Virtually the only small telco revenue source that saw an increase between 2008 and 2009 was Internet service, which grew 5.5% and represented about 12.4% of the average small telco’s total 2009 revenues, according to the Telergee data.

We also noted in our coverage of last year’s Telergee study that Internet connectivity was small telcos’ most important growth area At that time, several sources at Telergee Alliance accounting firms noted that carriers were hoping to see the Universal Service fund cover more broadband costs. Since then, the National Broadband Plan has recommended transitioning the USF to focus on broadband—but what the NBP proposes, to put it mildly, is not what the small telcos had in mind.

For starters, the small telcos were hoping for a target broadband speed higher than the proposed 4 Mb/s. Most of them already provide service at 4 Mb/s, which means network upgrades likely would not be covered by the new program.

Of even greater concern is that it’s not clear what, if any, ongoing Universal Service support small telcos that already have deployed broadband would be able to get for those networks—or even if all small telcos will remain in the program. The crafters of the National Broadband Plan are keen on the idea of awarding Universal Service funding based on a reverse auction that would award funding for an area to the service provider that asks for the smallest level of support. The FCC already issued a notice of proposed rulemaking that calls for a reverse auction to award funding to wireless carriers for areas of the country that do not have 3G service today. But what would happen if the FCC extends that approach to determining ongoing support levels in areas that already have broadband is far from clear.

On the one hand, it might seem difficult for anyone to underbid a carrier that already has deployed fiber. But the FCC has been promoting 4G wireless and satellite as a way of meeting the minimum 4 Mb/s target, which leaves open the possibility that a wireless carrier could underbid a small telco that needs ongoing support for a fiber network.

When I asked Blair Levin, who headed up the team that wrote the National Broadband Plan, about this recently, his answer was anything but comforting for small telcos. He said some Universal Service funding has been “irrational” and argued that small telcos essentially are saying, “Because you were irrational in funding us to do network upgrades that were non-economic, you have to forever be irrational and continue to do it.”

I asked him point blank if some small carriers might go out of business as a result of the reverse auction process and he said he didn’t know yet, but that the FCC was researching how to treat areas where broadband already has been deployed.

The wireless challenge

Much of the line loss that small telcos are experiencing is a result of wireless substitution, so it might seem that offering wireless service would be a logical response. But as the Telergee Study illustrates, it’s becoming increasingly difficult for small telcos to make a profit in that market.

Small telco wireless expenses actually exceeded wireless revenues by an average of 2.2% in 2009, according to the Telergee report, which stands in sharp contrast with what the large national carriers are experiencing. Even more perplexing is that the small telco profit dip occurred despite an average increase of 5.4% in wireless customer count.

Small telcos argue that they would be better able to compete against the large national carriers if exclusive handset deals were prohibited and if the larger carriers were required to allow the small carriers to roam onto their data networks at reasonable terms. Fortunately for the small telcos, that’s one area where the FCC seems to be sympathetic. The commission already has made some progress toward imposing data roaming requirements and appears open to considering some action on handset exclusivity.

The Telergee data underscores the importance of making those moves sooner rather than later.