Killer BLEC

It was the best of times; it was the worst of times. The opening line of Charles Dickens’ "A Tale of Two Cities" could be easily applied to the past year’s events for in-building service providers. Building local exchange carriers, known as BLECs, hit their stride in 2000. They gained ground in metro markets as they forged agreements with property owners and wired office buildings with fiber; their fast access, voice and data offerings and hands-on customer service style drew tenants within those buildings. But BLECs serve a niche market, and the road to success has been slower than initially imagined.

Allied Riser Communications was one of the first—and remains one of the largest—companies to outfit multi-tenant units (MTUs) with fiber optic cable for high-speed voice, video and data communications.

Founded in 1996, the company became a leader in the BLEC space. It operates in more than 675 commercial office buildings in 53 metro markets, covering more than 265 million square feet of

office space. And the build isn’t complete. ARC’s goal is to reach 800 million square feet at the end of 2004, says ARC President and CEO Gerald Dinsmore.

Growing up and liking it

To that end, the company last year purchased a majority stake in a Canadian conglomerate that gives ARC access to customers occupying 35 million square feet of commercial property. The group, Shared Technologies, owns, controls or manages more than 70 million square feet of commercial office space in Canada. The company also is looking to expand overseas—and in fact has agreements with some providers there—but hasn’t yet begun to build, Dinsmore says.

The average building tenant occupies 10,000 to 12,000 square feet. Assuming each person takes up about 250 square feet, the average tenant is a business with 40 to 50 employees. Though ARC concentrates on small and medium-sized businesses, Dinsmore hints that the company might expand its reach.

"From the smallest customer in a building to the largest, the value proposition is there," he says. "We execute on that strategy."

When dealing with small business customers without an IT staff, ARC not only provides the service, but its techs will power up PCs and ensure modems are configured properly. As the company moves up-market, customers likely have at least one IT staff member. ARC then focuses on more complicated connectivity issues such as changes to the LAN software, Dinsmore says.

"We understand that the customer needs are different if you get into the mid-market," he says. "We lead more with professional service capabilities and [not just] a bundled set of services [for companies that] have no IT resources."

One such customer, Hite, McNichol & Associates, is a five-person energy consulting firm based in Houston. Jason Cribbs is an engineer at the firm and doubles as his company’s IT contact. He was looking for high-speed access and bypassed Southwestern Bell in favor of ARC because the price and service were better, he says.

"We were using a dial-up account for Internet access and e-mail, but it was slow and inefficient," Cribbs says. "ARC was implementing infrastructure in our building, and they had a good proposal. We pay less for their high-speed access than we were for the dial-up account, and the service—terms and reliability—is great."

The energy firm handled the network connection itself on a Friday morning, and the same afternoon ARC installed the high-speed system. "On Monday morning we were back to normal but with high-speed access. We didn’t have any downtime, and that was one of our big concerns: no downtime," Cribbs says.

That’s the kind of installation that all BLECs want. Dinsmore is adamant, however, that ARC stay out of system integration and network design. "When you start doing that stuff, you have requirements for a whole different set of resources. We see somebody else doing that," he says.

Systems and services

ARC is still very much in the growth phase, not only in terms of geographies but also in the technologies it supports. The company offers branded services for e-mail, remote LAN and Internet access and security, business-to-business portals, Web design and hosting, Internet-based TV, and voice and Internet conferencing services.

One of ARC’s selling points is that customers that need it—small and medium-sized businesses—have more economical and flexible communications options, says Todd Doshier, ARC’s senior vice president and chief financial officer.

"We deliver a 10/100 Mb/s Ethernet connection," he says. "They can purchase a smaller bandwidth service—a 1 Mb/s port or 2 Mb/s or 3 Mb/s—and we can traffic-shape those connections with a router using IP traffic shaping." The customer can continue to increase its capacity up to 100 Mb/s and eventually into the gigabit range, Doshier says.

ARC uses equipment from Cisco Systems and has transport agreements with Enron Broadband Services, Qwest Communications, Level 3 Communications, Genuity, InterNAP and "several other CLECs and ILECs," Doshier says. Each building has four WAN interfaces and connects to the metro optical network via a broadband local loop connection such as a

T-1, DS-3, dark fiber, wireless or DSL link. ARC also is testing a wireless optical technology from AirFiber. The company uses a switch as the cross-connect to the router.

"All those [points of presence] are aggregated to a metro POP, then [we use] fiber to cross-connect to national service providers that give us access to the Internet," Doshier says. "We deliver a virtual wide area VPN without a peering point off the Internet."

Plans for profit

But just being flexible isn’t enough to sustain a business model. Dinsmore joined ARC in October to tighten up the ship. And he isn’t the only newcomer to the executive staff. In November, Terri Compton was named chief operating officer, replacing John Todd who left "to pursue other interests." Todd and former Chief Technology Officer John Davis left in September 2000.

Dinsmore wants to make ARC more efficient and more profitable. The company’s stock plummeted in April 2000 to less than half its yearly high of near $40 per share in March. It hasn’t recovered. At the end of 2000, the stock was trading around $1 per share, well below the dip in the Nasdaq, and climbed to about $2 per share at press time.

The new president promises to boost sales by further fragmenting its customer base and restructuring the sales team’s compensation plan. Dinsmore wants to segment customers and offer targeted products. The customers are localized, so subdividing the customer base for specific services should be fairly easy.

"You think [the customer base is] captive, but it’s not captive, though it is easier to market to," Dinsmore says.

That plays into one of his other projects: compensating sales people for "working the buildings," he says. The sales team will be encouraged to cross-sell services. Dinmore’s theory is that a customer of one service will likely add other services. It only works, however, if the services offered fit the customer’s needs, and even customers with a good experience won’t sign up for products they don’t need.

"In the future, I’d be willing to use ARC for additional services, but I wouldn’t just jump on the bandwagon to try things out," says Cribbs of Hite, McNichol & Associates.

Dinsmore will implement changes to the sales structure and product offerings to capitalize on the existing strengths of the company. He also will look at changing ARC’s distribution channels.

"We have all feet on the street for the most part now," he says. "There’s an opportunity for inbound/outbound telemarketing when you move down market into small business."

Building in buildings

Few people—and boards of directors—will snub their noses at streamlining a business to increase profits. But one problem that plagues all providers in the MTU/multiple dwelling unit space is the fixed cost of rewiring a building.

At the time of ARC’s IPO in October 1999, Doshier says, average capital expenditures ran about $150,000 to $170,000 per building. The costs were broken into three categories: construction of the riser raceway, construction of the building POP and the electronics provisioned into the building. With efficiencies in the construction process and architectural changes, the per-building costs have decreased to $60,000 to $80,000, he adds.

As that continues, costs will be cut in half again, Doshier says. "We are confident we can put scalable, highly provisionable, fiber optic infrastructure with electronics into these buildings that exceeds our current average penetration assumptions for in the $30,000 to $40,000 [per-building] range." The company publicly stated it is shooting for an average per-building capex of $30,000.

The benefits of decreasing the fixed costs are two-fold, Dinsmore says: It allows a BLEC to scale, and it lowers the break-even point for entering a building. ARC started in larger buildings and has since scaled into smaller buildings as costs decreased.

The company also played to its strengths, which are in-building networks. ARC teamed with partners—often real estate developers and property owners—to gain ground. The company’s aggressiveness has paid off, says Doug Morgan, ARC’s vice president of strategic national initiatives.

"We have a different relationship with the real estate community," he says. "We hired real estate professionals—they really understand the real estate business and construction, and we know how to work with them."

Those relationships allow ARC to get into properties quickly and easily. Throughout the build process, "people are willing to help us get it done," he adds. "It’s a calculated thing."

BLEC outlook

ARC is not concerned about the FCC’s recent decision forbidding BLECs to forge exclusive service contacts with property owners (see story on page 78).

"The FCC came down hard on exclusive agreements with real estate owners," Morgan says. "The FCC positioned itself as a strong supporter for building owners’ side of this discussion. The tenant should have a choice. Our agreements are not exclusive, and we wouldn’t grant it even if it were offered."

ARC says none of its agreements with property owners is exclusive and claims 45% penetration in the buildings it serves, though it targets 30% penetration. "I can’t name a handful that we are second in," Morgan says.

That could be more economical than altruistic. If another BLEC has wired a building, it likely has gained fair penetration. The profits would have to be substantial to draw in ARC, too. If it did, ARC would be battling against two incumbent carriers: the incumbent LEC and the first BLEC to offer service in the building. Though it’s not an impossible situation, it’s certainly less desirable than being the only other game in town.

ARC has made great strides in the space, but this past year was fraught with changes and has left some questioning the validity of the BLEC business model.

BLECs in general are taking a hit, says Jim Andrew, vice president of consultancy Adventis. "The business plan was marvelous," he says. "There was no one else going to build [in buildings]. That put [BLECs] in a very advantageous position. But if [regulators] force others to have access to their infrastructure, that advantage is taken away."

That’s not all, Andrew adds. Wall Street is shutting the cash flow spigot; BLECs were hit with the non-discriminatory access ruling, and the real estate industry proved a tough partner, he says.

"I don’t think most anticipated the experience they’ve had working with the building owners. There are a lot of up-front fees, and they want larger cuts of the revenue stream," Andrew says. "The real estate business is a tough business. The owners and managers of the buildings have struck tough deals."

Couple the fixed costs of wiring a building with the propensity for the building owners to nickel-and-dime the BLECs, and companies such as ARC will have a hard time surviving, Andrew says.

"I don’t like to be negative on a whole industry subsector, but reality has made it more difficult than they envisioned," he adds. BLECs could benefit from regulation that allows other carriers—including RBOCs—to buy from them.

"This is the last 100 yards," he says. "If they are the last mile, they can still make money from non-discriminatory access—they just don’t make as much money, and they don’t wind up with the customer relationship."

One problem with BLECs, Andrew argues, is that they have a very narrow market. "Have they sliced the value chain a little too thin? Well, wireless providers [do] everything ARC does in terms of wiring the building and can provide point-to-point and point-to-multipoint [services] in or out of the building. No one knows the answer, but non-discriminatory access takes a bigger bite out of their one chance for revenue."

That, however, does not scare the top brass at ARC. Doshier believes ARC has two advantages: The company is fully funded, and it has access to a lot of customers. "The other BLECs in this space are all private," he says. "They have access to large amounts of square footage, but they don’t have the same quantity of licensing agreements or square footage. We closed our quarter with $300 million in cash. We have already built out a network that is 280 million square feet in 750 buildings."

Despite the trials and tribulations of BLECs, ARC’s relative ubiquity is the light at the end of the tunnel.