ISPs and the fast track

The Internet service provider sector, one of the hottest in the communications industry, has been consistently reporting operating losses in the last few years. Facilities-based ISPs have typically reported an average operating loss of 15% to 20% on their income statements. Executives, investors and analysts have rationalized this as an inevitable outcome of infrastructure deployment and customer acquisition efforts.

Although it is to be expected that any growing business requires patience and nurturing from a financial perspective, evidence suggests that investor euphoria has been both directly and inversely proportional to the industry's ability to generate earnings. Share prices have risen relentlessly as negative earnings per share have declined consistently. In some cases, valuation models have gone as far as pricing stock as a function of the company's ability to spend rather than earn.

But a rapid scan of these companies shows that there are ample opportunities to get on the profitability fast track. While it is true that several ISPs are still building out their infrastructure and depreciating those capital investments, the lion's share of costs is, understandably, driven by operating expenses.

Analysis of these expenses reveals dynamics that indicate operating models that remain to be optimized. In other words, the most modern and cutting-edge of ISPs are often operating like the most traditional telcos when it comes to managing the value chain across core processes such as offer development, provisioning, network operations, customer care and billing.

While it is somewhat understandable that ISPs owned and operated by telecommunications giants could be afflicted with the parent's historic operating paradigms, it is puzzling that pure-play providers starting from a clean slate are perpetuating some of the endemic inefficiencies of the telecom world of old.

A flagrant example of this is that the very providers that are enabling companies such as Charles Schwab to totally redefine their business model through technology often are not deploying and using the same tools to re-invent themselves.

Other examples of the apparent lack of rigor in operations management are the wide variations in asset use, agent productivity and agent-use metrics within the sector and compared with other industries. A further symptom of sub-optimal operating process is the staggering proportion of internal employee inquiries-compared with customer inquiries-that customer service agents tend to answer.

It appears that even the most aggressive greenfield players are subscribing to cost-led revenue strategies. As such, they seek to ultimately drive enough revenue to cover a set of operating costs that they deem to be almost pre-determined and rooted in "oldco" inefficiency.

A more strategically astute approach would be to aspire to revenue-led cost models that compel executives to devise ways to be profitable and efficient at almost any revenue level they believe can be extracted from a market segment.

A shift toward efficiency of operations would go a long way toward boosting earnings per share, even in current buildout situations. From a market-acquisition perspective, ISPs will need to fine-tune their strategies and marketing to ultimately craft compelling value propositions that go beyond the realm of basic or even advanced connectivity.

There is a vacuum of value-added applications to be filled. But offerings such as Internet access, Web hosting or even Internet protocol-based virtual private networks will not fill it. Moreover, bundling and packaging will eliminate the issues associated with marketing offers that are almost custom-built. Commercialization of these applications would dramatically boost ISPs' top lines and enable the much-needed production of positive earnings.

The ISP sector has been and will continue to be a crucial sector of the economy, as well as a key source of national competitive advantage. It is therefore fundamental that executives and the investment community not foster nor recreate the telcos of yesteryear and instead focus on engineering the optimized infomediaries of tomorrow.