FADE TO BLACK

BLEC has become a four-letter word--the building-focused carrier model that once seemed like a sure thing has instead crashed and burned, the victim of a business model too narrow to evolve and too costly to sustain. But not everyone has checked out: Optical Ethernet providers Yipes and Cogent have so far managed to avoid the economic carnage that consumed their competitors. Just don't call them BLECs.

In the hours and days following the tragedies of Sept. 11, the Worcester Telegram & Gazette in Worcester, Mass., found itself with a major problem. The paper — the third largest in the state, behind only The Boston Globe and the Boston Herald — is a vital news source in central Massachusetts, and accordingly, thousands of readers flooded its Web site, their interest heightened by the fact that two of the doomed flights originated in Boston, a scant 44 miles to the east. At the same time, reporters were online as well, frantically digging for background information, and editors were busy downloading images to go with the stories their staff was writing.

The burst of activity nearly overwhelmed the site. But the reason it didn't was Yipes Communications. The solution for the Telegram & Gazette's IT managers was relatively simple: The paper ordered the bandwidth they needed from San Francisco-based Yipes for the length of time they needed it, which was about four days. Doing so would have been unthinkable had they been receiving their Internet service from a provider using ATM or Sonet-based platforms, but Yipes uses optical Ethernet as its fundamental technology, which gives the carrier the ability to offer scalable bandwidth.

“When someone connects to us, we can offer them bandwidth in 1 Mb increments, from 1 Mb/s to 1 Gb/s,” said Jerry Parrick, Yipes' founder and CEO. The Telegram & Gazette increased its bandwidth by a factor of five during the crisis period. Doing so was a snap — they simply jumped onto Yipes' site, plugged in how much additional bandwidth they needed and clicked to order.

“Imagine calling up the local telephone company and telling them you need six T-1s in 15 minutes, and you only need them for four days,” said Thomas Kenney, director of information technology for the Telegram & Gazette. “That's effectively what we got from Yipes.”

“Granular” bandwidth is something the industry has been working to develop for about 15 years, according to Parrick, who claims Yipes is the first carrier with the ability to deliver it nationally through its Yipes Now bandwidth-on-demand product. Parrick believes this ability gives Yipes a considerable edge in the multi-tenant unit (MTU) space. “When you think about [carriers] that are in a traditional ATM or Sonet model, they have no flexibility; they have to offer bandwidth in large-scale increments,” he said. “So they can't satisfy customers that have a need that falls somewhere in between.”

Parrick also believes Yipes' choice of optical Ethernet has allowed the carrier to avoid the misfortune that befell others attempting to serve the MTU space, notably building local exchange carriers (BLECs) — a sector that has fallen on such hard times that Yipes prefers not to be defined according to such four-letter terms.

And, of course, it also didn't hurt that Yipes had a better plan.

The MTU space is littered with the mangled husks of BLECs that showed great promise in the beginning but eventually succumbed to a flawed business model (see figure). Parrick, speaking as one who stands above the wreckage, believes the BLECs committed several blunders that Yipes managed to avoid. First, the BLECs created a universe of addressable market that was limited to specific buildings. “That seriously limits your ability to find a lot of customers because you're limited by the walls of that building,” he said.

They also burned a lot of cash. Parrick estimates the cost of putting dark fiber in the risers of a building and the terminating equipment on all the floors, depending on the size of the structure, at somewhere between $60,000 and $120,000. “They created a universe of addressable market that was too small to support their costs,” Parrick said.

Nick Maynard, an analyst for The Yankee Group's communications service practice, agrees. “The BLECs spent their money getting into as many buildings as possible, and they had very low penetration [of customers], so their debt payments just crushed them,” he said. “A lot of those guys spent hundreds of millions building out and ended up with maybe tens of millions in revenue. You just can't sustain that.”

Parrick also believes the BLECs “wanted to dig up the streets, they wanted to put their own conduit in, and they wanted to run their own fiber. I want to own the fiber, too, but if I can do it without digging up the street, I will.”

Yipes tries to lease conduit from others, typically the telephone company, whenever and wherever it can. “They have to make excess capacity in that pipe available to me under the pole-attachment tariff,” Parrick said. “We're a filed CLEC in all of our cities, so we have common-carrier status. If they have surplus conduit, they have to make it available at very inexpensive rates.”

BLECs also were indiscriminate in the buildings they targeted, due in large measure to the pressure put upon them by the real estate owners and managers that control building access, according to Maribel Dolinov, senior telecom analyst for Forrester Research. BLECs couldn't just pick the best buildings in a portfolio — they were forced to take the dogs as well, she said. “If you want Liberty Street in New York City, you also have to take Poughkeepsie.”

In contrast, Yipes developed a database to identify every company that has dark fiber in the ground in a particular city. On top of that, Yipes loads a Dun & Bradstreet database that can pinpoint any building that's near anyone's fiber. Based on this information, Yipes develops a rating algorithm that produces a probability-of-fail score for specific buildings.

“I can look at five buildings on a street and tell you which is the most attractive building. That's where I send my salesmen first,” Parrick said. “It's a rifle with a high-powered scope. There isn't anything that looks like a shotgun here.”

Greed also may have been a factor in the BLECs' rampant lighting of buildings, said Dave Schaeffer, founder and CEO of Yipes competitor Cogent Communications. Schaeffer suggested that investors rewarded BLECs for the amount of square footage they had under agreement so they would take the good with the bad. “They were kind of gluttonous in their appetite for buildings. They were not discerning in trying to get buildings that were profitable.”

Dolinov agreed with the greed notion but added another motivating factor: The BLECs were fattening themselves up in the hope of being snapped up by an incumbent carrier, a strategy she finds curious. “That was interesting given the mentality of the ILECs, [which] looked around, saw that the BLECs weren't growing and just waited for them to implode.”

And implode they did. As each succeeding BLEC fell, survivors found it increasingly difficult to compete. “People tend to be a little sensitive when it comes to their telecommunications,” Dolinov said. “They start asking whether their providers are going to be in business. It's hard enough for telecom managers to keep their jobs, so they don't want to do anything stupid.”

“These are typically very risk-averse folks,” Parrick said. “You have to show them that your network is carrier-class, that it is survivable and that it will deliver the performance consistently that they're looking for. If they perceive any risk, they won't give you an order.”

According to Schaeffer, BLECs also failed to grow their customer base because they tried to compete with the incumbents by offering traditional ATM- and Sonet-based services. “Almost all of the carnage can be attributed to the fact the products and services BLECs sold were no different than those that can be purchased from any telephony company,” he said.

There was some logic behind the BLECs' decision to build “very traditional” voice-based businesses, Schaeffer added. “If you look at the telecom universe in total, 85% of the revenue still comes from voice, so they wanted to focus on that revenue.”

As it turned out, however, the thinking was flawed. “There's a trillion dollars in embedded plant out in the market today, and much of that plant was paid for by the rate bases of the ILECs,” Schaeffer said. “It would be very difficult for any new entrant to compete against that.”

Even when BLECs were able to turn up customers in a building, they often were unable to deliver on their promises, according to Parrick. “Even when they had a very fast network in the building, it became very slow, very quickly when the traffic had to leave the building if the incumbent wouldn't give them a big enough pipe,” he said.

That's not a problem for Yipes' customers, thanks to the company's optical Ethernet technology, which also enables its bandwidth-on-demand offering. “Customers can dial up occasional service by ordering it themselves, which is sort of like pay TV — what a deal for the service provider. You don't even have to have customer service interaction,” said Michael Kennedy, co-founder of Network Strategy Partners.

There are other advantages. A big one is cost — the cost of transporting data over a traditional telephony network is very high, Parrick said, because the data has to be converted from one protocol to another to make it compatible with the traditional telephone network. But because Yipes uses “native” Ethernet, all it has to do is accept the traffic in its native format, aggregate it — still in its native form — and then transmit it across the country. Customers are provided with a native Ethernet interface, which makes it possible to plug the Yipes network into an existing router or directly into the customer's LAN without any protocol conversion.

Also contributing to the cost advantages is the enormous disparity in the production of Ethernet components compared with ATM and Sonet, said Parrick, who estimates that 10 million Ethernet ports were shipped worldwide last year, compared with less than 500,000 ATM and Sonet ports.

There's also a sizeable cost advantage to Ethernet from the customer's perspective. An MTU customer that wants to incrementally increase its bandwidth from a single T-1 (1.54 Mb/s) to 100 Mb/s, for instance, would have to negotiate an order and pay for a truck roll for each additional T-1 that's connected, up to six. Once the T-1s are in place, the customer can jump to a DS-3 (32 Mb/s). But that would require the negotiation of another service order, another truck roll and the purchase of new equipment.

“There's all this effort and cost over time to move from 1 Mb to 100 Mb,” Parrick said. “With bandwidth-on-demand, there's none of that. The customer is set up to grow to 100 Mb right from the beginning.” Another plus: Most IT managers are comfortable with Ethernet.

“When you look at our technology, there is very little risk,” said Parrick, who estimated that 90% of the data on the nation's desktops originate in Ethernet.

While both Yipes and Cogent have managed to stay clear of the wreckage that marks the BLEC sector today, analysts believe the MTU market is a slippery slope, and both carriers need to be careful if they want to avoid sliding into the chain-reaction pileup.

“Yipes has succeeded because they took fiber all the way to the building, but their [long-term] success isn't guaranteed at this point,” said Forrester's Dolinov. To assure its longevity, Yipes would need to improve its take rate, she said. “If they can prove those numbers, they will get more funding and be able to build out a larger network. They have good service. It's a matter of whether you believe they're going to survive.”

Parrick has come to a similar conclusion, but a larger network isn't necessarily the goal.

“The 20-city market we have is already big enough to allow us to sell into multi-location customers,” he said. “We're satisfied with our footprint.” Because financial markets are tight, Parrick said Yipes would instead target its capital to turning on more buildings in their current markets, rather than putting new infrastructure into new cities.

If Yipes and Cogent are going to convince investors and customers they are going to survive over the long haul, they must further differentiate themselves from CLECs and BLECs and the stigma that envelops them, said Ron Kaplan, senior research analyst for IDC. “Whenever a network manager reads about little telecom companies going out of business, it's a problem, especially if they're a medium to large company where it's a big deal to change providers,” he said. “Some of the network managers are wary of going with a smaller provider at this point.”

Though Cogent's pressures are similar to those being felt by Yipes, the carrier also is battling continued doubts stemming from its value proposition, which calls for customers to receive a non-oversubscribed 100 Mb/s capacity for the flat rate of $1000 per month. Analysts have long doubted the sustainability of that model, but those doubts have deepened since Cogent's acquisition of BLEC Allied Riser Communications, a deal first announced in late August 2001.

Because ARC is publicly held, Cogent was forced to execute a reverse IPO, which required them to file financial statements with the Securities and Exchange Commission. These filings offered the first glimpse of the company's financial footing, and the picture didn't appear bright: Through Q3 2001, Cogent had posted net sales of $747,000 against operating expenses of $43 million.

“They appear to be undercutting themselves. I can't convince myself that their model makes sense given the prices set by the other providers,” said Lizet Tirres, senior analyst for Stratecast Partners.

However, Schaeffer said Cogent only began revenue operation in that quarter, though it has been offering service since November 2000. In the meantime, Cogent's customers have been receiving service at no charge while the carrier worked to ensure the stability of its network.

“Customers were willing to pay us, but… we needed to make sure that when we went commercial we would deliver a quality of service that not only met our service level agreements but was a higher quality of service that was available from more traditional ISPs,” Schaeffer said.

Also troubling Tirres: Cogent has no long-term agreements with its customers — every deal is month-to-month. “That's bizarre, and it makes their model even worse than the DSL model. They at least force you to sign up.”

Both Parrick and Schaeffer agree that their companies' long-term health is tied to their ability to work more effectively with real estate owners and managers. In fact, the primary motivator behind both Cogent's acquisition of ARC and Yipes' $5.4 million purchase of Broadband Office last August was the building access agreements that came with each.

“The cousin that is in the basement that never sees the light of day and never gets introduced to guests, which the whole industry is keeping out of public view, is the difficulty of negotiating with landlords,” Parrick said. “This is hard work and it takes a long time. It's quite an art.”

Which made the building access agreements exceedingly valuable, Schaeffer said. “There is nothing that absolutely forces them to let you into the building. And for this type of network architecture — ours or Yipes' — you need to have a physical presence in the building,” he said.

The in-building infrastructures that both Broadband Office and ARC had built are also valuable. Sources close to the negotiations said Yipes turned the Broadband Office infrastructure over to the building owners as a negotiating chip during the rewriting of the building access agreements. But Parrick said the carrier received in return a commitment from the building owners: “They would make capacity available to us to the extent that we needed it.” Cogent, meanwhile, retained full ownership of the Allied Riser infrastructure.

Regardless of the path taken, retaining a connection to that infrastructure was a good move, Dolinov said, because a pre-wired building makes it easier for a carrier to sell customers additional services.

“It's the difference between selling a customer a car that comes equipped with a mobile phone and trying to get them to add the phone by selling them an optional package,” she said. “It's a helluva lot easier if it's already in the car, and all they have to do is convince the customer to turn on the service.”

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With additional reporting by Toby Weber in Chicago.

YIPES COMMUNICATIONS

• Founded: July 1999

• Headquarters: San Francisco

• Serves 21 markets nationwide, including New York, Chicago, Los Angeles, Boston and San Francisco

• Management team:

Jerry Parrick	Founder and CEO
Ron Young	Co-founder and chief
marketing officer
Kamran Sistanizadeh	Chief technical officer
Rob Valdez	Chief financial officer

• Funding:

First round — $13.8 million

Second round — $77 million

Third round — $200 million

BLEC SCORECARD

Company	Fate
UrbanMedia	Crumbled early February 2001
BroadBand Office	Declared Chapter 11 May 2001; building access rights bought by Yipes July 2001
Allied Riser Communications	On verge of bankruptcy; purchased by Cogent August 2001
OnSite Access	Declared bankruptcy May 2001; selected assets bought by eLink Communications
Everest Broadband	Announced fourth funding round Jan. 4
Cogent Communications	Bought Allied Riser August 2001; rolled out to 20th city November 2001
eLink Communications	Bought New York and Washington assets of OnSite Access
Cypress Communications	Bought by U.S. RealTel January 2002
PhatPipe	Merged with E-Building
Wired Business	Purchased by WebAccess
Skyway Partners	Apparently bankrupt; URL is down, and phone is disconnected
EurekaGGN	Received $20 million in funding in July 2001
IntelliSpace	Secured $70 million in funding in October 2001

FOR AN IN-DEPTH LOOK AT COGENT, SEE THE JULY 9 TELEPHONY FEATURE, “PROMISES MADE, PROMISES KEPT”