DSL: Worth a second look

Some CLECs may think cable modems have them beat, but considerable commercial opportunities for DSL service have made its success a foregone conclusion

The surging growth in corporate intranets and extranets has made frame relay and business Internet services the fastest growing segments in the data communications industry. Indeed, the projected growth of these markets during the next three years is estimated at 200% and 500%, respectively, according to recent research reports. This rapid rise and widespread adoption has created a significant business opportunity for competitive local exchange carriers, especially in the provisioning of new, high-margin services to existing customers.

Still, the CLEC is encountering barriers to competing successfully in this market. To serve businesses that are not directly on its current fiber infrastructure, the CLEC must lease wholesale T-1 and 56 kb/s circuits from incumbent LECs (ILECs) for resale. As a result, the CLEC is placed at a significant price disadvantage. At the same time, many businesses are finding that procuring traditional T-1 service from RBOCs can be a difficult, time-consuming process. Hence, business end users and CLECs are searching for alternate solutions to obtain service from the RBOCs.

CLECs have a compelling alternative: installing next generation access equipment at the LEC central office (CO) and leasing cost-effective, unbundled copper loops. As a result, the CLEC can offer megabit Internet data services at a significantly lower price point and control the delivery of those services. Cost savings are passed on to the business end user, who also benefits from the more flexible service available from smaller companies.

The early adopters of symmetrical DSL (SDSL) technology - packet CLECs and data CLECs - have shown the value of building a facilities-based network to deliver services to business users. Furthermore, Wall Street has recognized the importance of these strategic assets and has funded the rapid expansion of their networks willingly.

Until recently, traditional CLECs offering voice and bundled voice and data services could not take advantage of the DSL rollout. The emergence of voice-over-DSL equipment has provided the missing piece. Now CLECs can take advantage of the significantly lower cost of delivering service over SDSL circuits - maintaining their high revenue voice business while growing the higher margin data business. Figure 1 shows the topology of a voice-over-DSL network.

Mixed messages

Some of the rub on DSL deployment has not been good. Some maintain that cable dominates DSL deployment and that DSL has no hope of winning residential users. Such viewpoints have been so pervasive that the underlying message is this: If you can't offer DSL at cable modem prices, then don't bother to get into the business. Although this obviously is slanted for consumer deployments, this perspective bleeds into commercial DSL serv ices: If you can't beat $50 per month, then don't even try.

The real DSL business story is in the fast-growing frame relay and business Internet services. Data aside, a $50-per-month service will not provide the multiple voice lines that a small or medium-sized business needs. The direction in which commercial DSL is headed has resulted in this inevitability: If you offer voice over DSL, you will survive and thrive; if you don't, you'll surely perish. This is true whether you're a CLEC, IXC, ILEC, ISP, ICP or whatever acronym you choose. The good news is, from a commercial deployment perspective, DSL has never looked better.

To date, the common strategy for DSL in the local loop arena is for data CLECs to offer wholesale access to partner ISPs or their own version of high-speed Internet access. But so far, there have been few DSLs deployed to support "traditional" public data and multiline voice services. The opportunity to deliver data and voice services over DSL economically has just begun, and the competitive landscape is still very open.

DSL has an important role to play for any CLEC, and a facilities-based co-location approach brings out the most impressive opportunities. True, "facilities-based" may mean considerable capital investments and a longer time to market if a carrier is starting from ground zero. But deploying DSL in co-location space or some similar arrangement (such as carrier hotels) and going through an interconnection process can take nine months or longer. CLECs must undergo vendor evaluations and service development or make modifications to their existing data services to add DSL access. But the advantages of facilities-based DSL lie in the control the CLEC has over all aspects of the solution, including hardware, pricing, reach and timing.

The results and rewards of DSL can position local carriers for long-term success and directly affect the bottom line of the business. Many CLECs examined the DSL business case early and couldn't make the numbers work, particularly because the voice business could not be bundled in. But DSL equipment capabilities have improved, voice has been added and pricing has decreased to a level that now makes the business case worth a second look.

Crafting a business case

Carriers tend to react to competitive pressures without fully understanding the effects on their business. One way to get a quick snapshot is to put together a business case that outlines the major revenue opportunities and expected expenses. Over time, this initial case can be improved and modified to present a living snapshot of the DSL network. At least at a high level, service providers can track success and manage executive expectations to a more reasonable level.

There are probably about as many approaches for developing a business case as there are recipes for chicken soup. The variations are endless, but they all are built on the basics of identifying revenues and expenses for deployment. Some of the major items are outlined here, but CLECs should keep in mind that real figures depend on their particular service strategies, internal costs and local market prices.

Picking out the revenue opportunities is fairly straightforward. Non-recurring charges typically are applied for installation of the service and equipment, and recurring monthly charges cover the service itself. Pricing for each of these items can run the gamut from bargain basement to luxury levels, depending on the carrier's competitive situation and service strategy.

In addition to standard network expenses, DSL means added start-up fees to acquire co-location space, monthly rental for the space, capital for equipment (including DSL access multiplexers, voice gateways and customer premises equipment), equipment installation and maintenance and backhaul costs to bring the aggregated traffic to the network.

In addition to these basic items, the CLEC needs to make assumptions about how to grow its DSL access network, which will have an impact on how quickly it achieves payback and a return on investment.For example, the number of COs added throughout the year increases capital expenditures. Also, the number of customers served from each CO affects the revenue stream and how quickly the carrier can break even. Predicting customer demand on an individual CO basis is tedious and difficult; a carrier might try starting with an "average number of customers" assumption and then adjust that figure over time as it tracks the service (see textbox on page 54).

The service strategy also affects revenue. Is the carrier offering a "DSL service" or using DSL transparently to support voice, Internet or frame relay? With the transparent network architecture approach, the carrier doesn't define or launch any new services, but it adds DSL as an access option for customers. The following are some of the advantages:

- The sales cycle does not change because customers still are buying "frame relay," voice lines, etc.

- Marketing costs do not increase for the same reason.

- Reduced access costs provide more profit than traffic by simply passing through ILEC access circuit costs.

However, because a growing number of DSL services are on the market, CLECs also should expect some of the following:

- The sales cycle time will be longer as the sales force and the customer base learn the new service.

- Service pricing most likely will be lower than private line delivery to attract new customers.

- The carrier must position DSL against any existing data services and ensure that it doesn't cannibalize other revenue streams.

- The CLEC should increase sales and marketing costs to educate customers and launch new services.

The distribution of customers subscribing to different service speeds will affect profitability. For example, if DSL access is used to supplement a frame relay service, at 56 kb/s levels, the profitability most likely will be much lower than at higher speeds. This depends on local market prices. One option is to increase the provisioning costs, which can account for the additional time spent on turning up customers. CLECs also should account for some costs to maintain the DSL equipment. Training is yet another item that should be budgeted - how much depends on how many groups need to be trained and the type of training involved.

Looking at the bottom line

Of course, the prospect of offering a new service usually comes down to money. Is there a compelling business case for adding DSL to a CLEC's business data portfolio? The answer is yes.

This becomes apparent when examining what happens when DSL is used to support off-net customers for existing voice and data services. Normally, to support off-net customers, CLECs purchase an access circuit (usually a T-1) from the ILEC and pass the added costs on to the customer. By adding a facilities-based co-location DSL network, the CLEC can gain some margin on the DSL access line that normally would have been passed through to the ILEC with zero gain.

Using fairly conservative benchmarks, cash flow becomes positive in year two and overall net margin increases by an average of more than 30% percent. Figure 2 shows the comparative gross margins over a five-year deployment plan.

Of course, adding DSL brings more than just bottom line benefits. DSL access networks complement CLEC architectures by extending geographical reach beyond fiber rings more cost-effectively than backhauling connections through the ILEC. This can expand the customer base while giving more room to respond to competitive situations.

Finally, DSL positions the carrier for layering or bundling services to new and existing customers. This increases the "stickiness" of the carrier's solution and can result in lower churn and more stable revenue streams.

Controlling the customer access confers ownership of the customer. The bandwidth that DSL offers is a building block for the next generation local loop, supporting several layers of applications beyond carrying voice and data traffic. By eliminating the local loop bottleneck, applications will reside where they are most efficient and economical; therefore, DSL will enable additional service offerings in the future.

A CLEC's business case analysis that compares DSL vs. leased T-1 access should consider these factors:

Input information

Revenue/volume

- Co-location rollout plan

- Customer/circuit ramp-up rate

Revenue/prices

- Service initiation charges

- CPE charges

- Recurring service prices

Operating expenses

- Leased T-1 rates

- Initial co-location

- Recurring co-location

- Interconnection charges

- Unbundled local loop rate

- Backhaul circuit rate

- Service initiation costs

- Network operations

- Provisioning

- Sales and marketing

- Maintenance services

Capital expenses

- CPE equipment

- DSLAM equipment

- Voice gateway

Financial parameters

- Accounts payable aging

- Accounts receivable aging

- Depreciation

- Interest rate

- Tax rate

Output information

Income statement

- Revenue

- Expenses

- Gross margin

- Net income

Cash flow analysis

Balance sheet

Return analysis

- EBITDA

- NPV

- IRR

- Break-even date

- Break-even number of circuits

Capital expenditures analysis

Capacity loading analysis