BLECs, Act 2

Modifying the business model

The core value proposition of building local exchange carriers must have been tantalizing to the first movers: By placing equipment in the basement of a building instead of a central office, carriers could accelerate provisioning and lower network transport costs. Deploying fiber in the riser could provide high bandwidth for coming applications. What's more, on-site technicians could provide high-touch customer service.

Eureka! This business model would give them instant cost and service advantages over incumbent carriers, which may take four to six weeks to provision a service and are probably strangers to the customer. In addition, it would give BLECs a leg up on incumbents, which are still conceptualizing metro fiber builds.

It's easy to see why numerous start-ups leaped into the multidwelling unit and multi-tenant unit markets hoping to stake their space. But the race to lock up properties, wire decommissioned mail chutes and haul switches, routers and PBXs into basements has slowed from a sprint into a jog. The dry-as-dirt capital markets played a role, but other reasons more fundamental to the BLEC business model contributed.

First, the operational savings that would supply the margins for BLECs just weren't a strong enough weapon against the mighty RBOCs. "Operation savings are generally insufficient - incumbent carriers have scale and can dramatically drop their price whenever they're pressured," said Cathy Gadecki, vice president of strategy and solutions for Ellacoya Networks, developer of a service generation system.

Second, many service providers took a cookie-cutter approach to spending on building infrastructure, she said. They deployed fiber in each building in which they gained access without profiling customers on a building-by-building basis.

Finally, remember those services that were going to be turned up so quickly? Well, many of them still are half-baked.

"It's going to take a little more creativity and targeting to come up with the right services," said Tim Weis, senior consultant for TeleChoice.

The failure of the "old" BLEC business model was painfully evident a few months ago when Allied Riser Communications, the industry darling, introduced a scaled-down, slowermoving business plan. The BLEC lowered the target square footage for in-building networks in 2001 to 100 million square feet from 240 million square feet. It also slashed the average capital expenditure per building to $30,000 from $120,000. These infrastructure cuts would be accomplished by reducing the size of the switch and router initially deployed, using existing wire raceways for installation of smaller conduits and using existing copper wiring in small buildings.

"We had the copper-fiber model all along," said Joseph Basile, CEO of OnSite Access, a provider targeting commercial office buildings. "We've focused our approach on a cost-effective return on assets. We wire in copper and put in an infrastructure of fiber, but we will not connect it until we have customers that require it."

Regardless of who used it first, the idea of cost-justifying investment in a building before deploying equipment is catching on. By a process it calls "underwriting," Everest Broadband lets the economics drive the engineering, said Jeffrey Feldman, CEO of the company.

Everest first reviews the achievable revenue building-by-building before taking one under contract. The research it conducts examines tenant demographics, including type of business and number of desktops; potential customers' demand for applications that drive bandwidth consumption; physical and engineering factors; and competitive risk, including other companies in the property, where in the planning or wiring stage they are and how much penetration of the customer base they've achieved.

It then models the capital expenditures alongside the anticipated revenue stream, looking for profitability in 18 to 24 months, Feldman said. After that, it aims to hit a return on investment, or hurdle rate, of at least 25%. "We understand the tenant mix, determine what they'll buy and look at leased-line costs and capital expenditure. We make all that fit the expected penetration in the building," Feldman said.

Everest acknowledges it built out in some "dog" buildings, but it also has walked away when the numbers didn't work.

With the FCC disallowing property owners from forming exclusive relationships with BLECs, the competitive assessment can be the most important metric of whether or not to enter a building, Weis said. "The biggest difficulty among service providers is that they have to achieve a very high [tenant] penetration rate to survive - between 30% and 40%," he said. Indeed, if a BLEC is third or fourth in a building, it probably should stay away, Feldman said.

The plethora of competition - especially in the market targeting commercial buildings that house small and medium-sized businesses - means that a relationship with the property management can make or break a BLEC.

"It's one thing to sign a contract to have access, and it's another thing to have management glad that you're there," Weis said. "[Management] can't give exclusive rights to a building, but that doesn't mean [it] can't give preferred [rights]."

There are many ways to grease the skids. OnSite Access, for example, sends salespeople to talk to a building's potential tenants about the property's telecom capabilities.

Urban Media goes further, offering building management and tenants free connectivity as an appetizer. A building often will mention free bandwidth as an amenity when it advertises for tenants, said Jeff Barnell, Urban Media's vice president of marketing.

But the bandwidth giveaway by Urban Media is also designed to achieve customer penetration. Urban Media claims it can absorb the cost of transport because its network services multiple buildings in a metropolitan area from a regional network center. Advanced technology such as small termination devices that separate voice and data traffic help support the model.

"You put enough equipment into the building to provision quickly but leverage the equipment in central offices," Barnell said. "The cost customer acquisition rate is higher, and the cost of acquiring customers is lower."

Most BLECs and their vendors disdain talking bandwidth, however. They say the real gravy will be in future value-added network, content and application services. Long-term success in the space will require a surfeit of such targeted applications for tenants. "The next year and a half to two years you can still get money for transport," Feldman said. "I don't bet on which application, but I want to be there to aggregate it."

Wired Business Company revenues: Not available

Venture capital financing to date: $20 million

Number of buildings served: 500

Number of customers: Not available

Number of cities with company footprint: 20

BroadBand Office Company revenues: Not available

Venture capital financing to date: More than $100 million

Number of buildings served: More than 40001

Number of customers: Not available

Number of cities with company footprint: More than 35

OnSite Access Company revenues: Not available

Venture capital financing to date: $186.5 million

Number of buildings served: 555

Number of customers: Not available

Number of cities with company footprint: 22 markets in U.S. and Canada

Allied Riser Communications Company revenues for Q3 2000: $4,403,000

Current stock trading value: $1.782

Number of buildings served: More than 700

Number of customers: Not available

Number of cities with company footprint: More than 50

Cypress Communications Company revenues for Q3 2000: $3.6 million

Current stock trading value: $0.752

Number of buildings served: 340

Number of customers: More than 2000

Number of cities with company footprint: 133

1 Broadband Office has access to more than 4000 buildings, but not all are lit

2 As of Jan. 8

3 Cypress operates on a wholesale level in 15 additional cities for a combined total of 28 cities

Venture-backed communications and networking IPOs in 2000 Overall, the IPO market slowed to a trickle in the fourth quarter, as only 16 venture-backed companies went public, raising $1.4 billion, according to VentureOne. That number of IPOs was the smallest since 1998's closing quarter. For the entire year, 193 IPOs raised $18.4 billion, compared with 244 IPOs raising $19.1 billion in 1999. Only five venture-backed communications and networking companies entered the public market in the fourth quarter of 2000, compared with 11 in the third quarter. Capital raised dipped from $2.2 billion to $529.9 million. The largest IPO was by fiber optic component maker Oplink Communications, which raised $246.6 million in October.