Sep 25, 2006 12:00 PM,

NECA blows the whistle on the packet train

By Stephanie Dell

Independent telcos know better than anyone that the broadband packet revolution is alive and well across rural America. Yet they encounter many obstacles in their attempt to lead it.

The National Exchange Carrier Association laid it all out in a recent report called “The Packet Train Needs to Stop at Every Door” and tried to answer the question: What is it going to take to bring a basic triple-play package to rural America?

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The report looked at the cost of infrastructure upgrades, market trends and shifts in inter-carrier compensation and universal service funding. It found that the challenge of delivering broadband packet infrastructure to rural areas today can be likened to the challenges telephone companies faced in the 1930s when bringing basic telephone service to remote areas, said Victor Glass, director of demand forecasting and rate development for NECA.

“This is a rapidly evolving market; the demands for capacity are growing yearly and markedly, and the demands for different types of innovative services are almost insatiable,” he said. “Policymakers need to address this, otherwise rural consumers will be out of luck.”

Glass said the study is not a position paper but rather an informational report meant to keep policymakers apprised of the realities independent and rural telcos face. Several groups received the report, including the FCC, the National Association of Regulatory Utility Commissioners, and the National Telecommunications and Information Administration.

Demand for traditional voice service is declining by about 1% per year as DSL service grows by about 25% per year, according to the report. But independent and rural telcos are keeping up with the rate of DSL adoption in more urban areas. Penetration rates were at 12% in rural areas, compared with 14% nationwide in 2004, even though rural carriers must cope with lower-density markets and more expensive operations. The gap is expected to increase, though, when rural providers try to build out to even more far-flung areas, or what the report refers to as “underserved markets,” those least likely to lead to a return on investment.

“Going forward, when you try to get to these remote customers, the gap may widen, but right now, they're holding their own,” Glass said. “But to really get to these remote customers, telephone companies requires a broad-based effort on the part of policymakers.”

For the purposes of the study, an 8 Mb/s pipe was selected as a reasonably sized target package that can accommodate voice service, two standard video streams and a 1.54 Mb/s Internet stream. That service seems to be widely available in other areas, Glass said, so NECA chose it as a baseline.

Of course, consumer demand for triple-play services determines pipe size, but according to the report, rural telcos will need a material increase in capacity to meet the demand, whether those services are provided by rural telcos or other service providers using the rural broadband networks. NECA surveyed a sampling of rural telcos, and based on that information, has estimated that the additional one-time cost of upgrading 5.9 million rural telephone lines to 8 Mb/s is $11.9 billion.

The study stresses that that cost isn't the end of the story because as consumer requirements and technology change, more investment will be necessary. Nor does the $11.9 billion cost cover operating and overhead costs such as modems, routers and set-top boxes, nor the cost of acquiring video content for a triple-play package. The unserved market accounts for $6.8 billion of that $11.9 billion. Upgrade costs range from almost $4900 per line for unserved areas to around $1000 for a customer served from the central office or a mid-range service area.

And it's not likely that delivering a triple-play service would be very profitable for these companies. The study found that the monthly cost to provide Internet and basic services might exceed $92 per household, yielding little profit for service providers that offer such a package for $99. And competitors can easily undercut that price.

“It's hard to make a business case for $99 a month or $70 net, and that's excluding the cost of delivering the package,” Glass said. “Even as you upgrade the lines, the basic triple-play package is not quite profitable on average throughout the rural space. And it will require some creativity on the service providers' part to make it profitable. It's not a slam dunk, even if you have a big enough pipe to every customer.”

Carl Murray, strategic technologies director for SureWest Communications in the Sacramento, Calif., area, said several new technologies are making it easier for rural carriers to meet the broadband demand, including continued improvement of copper plant, ADSL2+ and VDSL2 — technologies he says will help support existing infrastructure. Such technologies are more expensive to deploy, he said, but ultimately more cost-effective in the long run.

“Even if you're using your existing infrastructure, there's an investment in going out and cleaning it up, cutting out bridged taps, redoing old splices,” Murray said. “However, it's more cost-effective because of the business case behind it. You're providing an advanced level of service. You can start out with Internet, you can start out with point-to-point connectivity or you can go into TV. Once that infrastructure and that pipe is in place, we can start layering additional services on top of it.”

Even if carriers can make an acceptable business case, there are other barriers in place for multimedia packages, Glass said. These include video content availability, fair pricing of services and other types of technical requirements that block assembling these services and delivering them in rural areas.

“Regulators, if they want to provide universal service at comparable prices throughout the country, need to broaden their perspective. They need to not simply look at the adequacy of the pipes or the networks out in rural America, but make sure that the market is free enough so that you can assemble these packages and deliver the services,” he said. “It's not simply dollars; it's also setting the right conditions to provide these packages.”

In the past, rural providers have relied on a combination of network cost recovery from end users, inter-carrier compensation and universal service funding to maintain their networks and services. The NECA report maintains that universal service funding remains vital to continuing funding in rural areas, but legislation and regulation have not caught up to the packet revolution. One thing that is certain is that a carrier-of-last-resort must be responsible for providing advanced services to rural customers. But Glass said it's beyond the scope of the USF to mandate that video be included in that.

There's no doubt, though, that rural and independent telcos are a diverse bunch, providing service with various levels of technology nationwide. Phil Erli, general manager of Ringgold Telephone Co. in Ringgold, Ga., which provides triple-play service packages, said that in many ways, independents and rural telcos are ahead of the bigger companies because their smaller access line numbers allow them to have a more specific focus — they live and breathe their smaller markets.

“There is no digital divide in the independent telephone marketplace,” Erli said. “The digital divide is in rural areas that are served by large telephone companies. … Why should they spend the money to build DSL and other services out to those marketplaces when they've got better markets to build it in?”

Erli said despite the cost factors, rural independent telcos are committed to delivering the best service they can to their customers, including broadband.

“The ARPU on it may not be as great … but it's part of economic development — it's part of community development,” Erli said. “I think we as a group hold ourselves to higher standard than the large telephone companies do with regard to making those services available to our customers.”

Despite these providers' steadfast determination to bring the latest technologies to their customers, the NECA study shows that the average cost of originating and delivering multimedia services suggests that “a basic multimedia package, by itself, may not be profitable in rural areas absent significant additional revenues from advertising and premium services and government policies that support reasonable access to broadband networks and video content.”

For loop upgrades alone, NECA said, adding operating expenses, overhead and depreciation expenses plus a return on investment yields a $3 billion annual revenue requirement. That's a pretty big obstacle.