FINDING DSL'S SWEET SPOT

The telecom industry is in a quandary over DSL. Penetration in North America is still dismal compared with other parts of the world, and as carriers have become more conservative in their spending because of economic and regulatory concerns, there's little prospect for improvement in the near term.

Myriad factors hold back DSL. One is the lack of consensus among carriers and vendors on how to accelerate adoption. Price is also a culprit. It's obvious that the difference between dial-up service (which generally costs about $23 per month) and high-speed service (which ranges from about $50 to about $75 per month) is too large a chasm for most consumers to leap.

According to the DSL Forum, the Asia-Pacific region accounts for 43% of DSL subscribers worldwide, compared with 30% in North America. And while the population of Asia-Pac is more than double that of North America, which would explain this disparity, consider this: Western Europe, which has a far smaller population base compared with North America, accounts for 23% of total subscribers worldwide. On top of that, DSL is the second horse in a one-horse race with cable modem service, which accounts for about 70% of the domestic market.

It's apparent that lowering the price of service would result in customers reaching for the phone. Japan's NTT DoCoMo introduced a lower-priced DSL offering last fall and immediately saw subscriptions surge. Bell Canada had a similar experience when it dropped its DSL prices to a range of $21 to $35 per month (depending on service level), according to Piyush Sevalia, director of product marketing for chipset manufacturer Ikanos. “I'm at a loss as to why U.S. carriers haven't started to drop prices,” Sevalia said.

Actually they have, to a limited degree. Many carriers are promoting low-ball introductory rates designed to land customers. The hope is that once they're hooked, consumers will become so enamored of their broadband connections that they'll clamor for an array of high-margin value-added services.

Qwest Communications, for example, offers DSL for $39.95 per month or it provides a basic connection for just $21.95, allowing customers to choose their own Internet service provider. “Our goal is to get people interested and then upsell,” said Steve Bartholet, Qwest's director of DSL product marketing.

Others believe the answer is for carriers to migrate to tiered pricing programs. “Carriers need to get customers to pay by the drink,” said Keith Higgins, vice president of marketing for broadband access and aggregation equipment vendor Copper Mountain Networks. Higgins further suggested that carriers develop pricing approaches similar to those offered by airlines, where customers have a choice of flying first class, business class or coach.

“Most people believe that flying is better than driving over long distances, even if they're stuck in coach,” he said. “The fact that you don't have to use dial-up is worth the extra $9 a month.”

Randy Trombly, general manager of Plattsburgh, N.Y.-based competitive carrier Westelcom, agreed. “DSL is a value proposition and needs to be marketing driven. That means tiered pricing. Most people don't need speeds of 768 kb/s for $50. But people will go for 384 kb/s at $29 a month.”

There are some challenges associated with a tiered pricing strategy. For starters, such an approach would complicate the billing process, and the back office isn't a model of proficiency for most carriers.

“Carriers traditionally have had trouble adjusting their billing systems to accommodate changes they have made in the services they deliver,” said Nelson Hsu, senior director of business development for IP access equipment vendor Integral Access.

Another problem with dropping DSL prices is that infrastructure costs are largely fixed and don't vary based on the level of service. Carriers theoretically would need to shorten their margins to accommodate lower-priced levels of service, which they typically don't like to do.

For example, Verizon Communications provides service at $29.95 for the first three months, and then converts customers to the normal $49.95 per month rate. It does this because margins on DSL are slim at this point, and a carrier can't provide a service as a loss leader forever.

“If we could get the incremental cost of providing a data stream into the home below $20, we would see a reasonable margin,” said Michael Bolduc, director and general manager of Verizon Online. “Right now there is no gross margin.”

In a press briefing at Supercomm last month, Lawrence Babbio, vice chairman of Verizon, said DSL prices could be 30% to 40% higher than they are now if the carrier based its prices strictly on the cost of providing the service. However, Babbio stressed that the carrier has no plans to increase its standard prices.

Absent price increases, then, carriers wishing to increase their margins must find a way to drive down the cost of deploying and operating DSL services. Vendors are all too eager to help them do this. Some vendors have developed solutions that converge the key technology elements that make DSL possible — DSL access multiplexers, ATM switches, subscriber management systems and IP routers — into a single box.

When such elements are provisioned individually, acquisition and operating costs are “very high,” said Ali Kafel, vice president of marketing for equipment vendor Advanced Fibre Communications. “Combining these elements on an integrated platform results in lower capex costs and lower operating costs because it's easier to learn and operate one box than four,” Kafel said.

Other solutions focus on improving the density and reach of loops. Extending the reach of loops to as far as 18,000 kilofeet is particularly important because millions of Americans are unable to get DSL service, even if they are willing to pay for it. (Reach currently is limited to about 12,000 kilofeet, with 8000 kilofeet being the point where service quality generally begins to drop off.) Vendors also are working to develop better compression technologies to improve the delivery of video and to better facilitate bandwidth-intensive applications such as online gaming.

Of course, all this feverish research and development means nothing should carriers be unwilling to invest in the technology. And right now, incumbent carriers — specifically the Bell companies — are reticent to throw money at DSL because they are unhappy with the current regulatory climate. The FCC's current interpretation of the Telecom Act of 1996 requires incumbents to share their data facilities with competitors at prices the incumbents claim are below their cost, which strikes them as being unfair. So they mostly sit and wait, hoping for regulatory relief from Congress or the FCC. In the meantime, DSL progress spins its wheels in a field of quicksand.

“Until they believe the regulatory threat has been lessened, they won't deploy DSL,” said Van Cullens, president and CEO of DSL equipment vendor Westell. However, Cullens said he believes that both Congress and the FCC are quickly coming to the conclusion that the act “hasn't done what it was intended to do” and that change will be enacted, perhaps before the end of the year.

While regulatory relief likely would get the capex spigot flowing again , bringing DSL to the neglected doesn't solve the dilemma of how to get them to purchase the service. To get that to happen, some believe the carriers need to stop looking at DSL as a premium service.

Charles Kenmore, president and CEO of access equipment vendor Anda Networks, said carriers should heed their own histories in this regard. According to Kenmore, touch-tone service was marketed as a premium service when it was first introduced. And like DSL, it achieved a disappointing take rate. Eventually, carriers determined it would be more profitable to put touch-tone into the network as a standard service, and then layer on other premium services made possible by touch-tone.

“I don't think there's a carrier today that, when looking back on that decision, would tell you they made a mistake,” Kenmore said. “Other than they took too long to do it.”

Some believe the layering of premium services similarly would speed adoption of DSL. That means carriers are going to have to get into the content business.

“Half of the population is content with surfing the Web,” said Jim White, vice president of marketing for Alcatel's U.S. broadband networking division. “To get the attention of the other half, carriers are going to have to deliver services, and not just to the PC. They're also going to have to bring services to other devices in the home.”

Verizon's Bolduc acknowledged that it's difficult for consumers to think of telcos as video-on-demand providers. “To change that, we're going to have to develop a strong link to content.”

While partnerships with content providers such as Yahoo are valuable, carriers need to look beyond the obvious to realize the full potential of DSL, said Tony Marson, analyst with Probe Research.

Singapore Telecom stands as one example of how to accomplish that. The carrier struck deals with major U.S. movie studios to provide downloadable movies to its customers, after discovering the city had a profound shortage of movie theaters. The result: DSL subscriptions jumped, said Marson.

AOL is another example of a company that has turned an understanding of what customers want and are willing to purchase into spectacular results, said Marson. “They have created an environment of addiction where people feel they can't do without AOL.”