A Dynamic Perspective on Government Broadband

Initiatives

Jerry ElligSenior Research Fellow

Municipal electricity, gas, water

Slow technological change Necessities Monopolies

Not characteristics of broadband!

Creative Destruction

“competition from the new commodity, the new technology, the new source of supply, the new type of organization – competition which commands a decisive cost or quality advantage and strikes not at the margins of the profits and the output of existing firms, but at their foundations and their very lives.”

-- Joseph Schumpeter

Dynamic competition ≠ Static monopoly Competition Performance competition Continuous improvement Lock-in Obsolescence Risk Uncertainty

Competition = lower penetration rate Muni plans assume 22-55% penetration

(implies extremely high market share)

Private penetration rates, 2004 Cable modem 18% (60% market share) DSL 14% (37% market share)

Some munis achieve 40% penetration, while making big losses

Performance competition

How fast? Does high traffic slow speeds? How safe from hackers? Can communications be intercepted? Effective parental controls? Copyright protection? Tech support? Wired or wireless? Wireless reception? Good enough to support VoIP?

Performance – speed vs. cost

DSL: $14.95-32.95/mo for 1.5 mb (about 1 cent/kb)

Cable modem: $40-45/mo for 4-10 mb(1 cent/kb or less)

Few govt. wireless services below 2 cents/kb Some muni fiber comparable to private price Muni cable modem comparable to private

price

Continuous improvement

Real CPI for Internet service fell 23% since 1997

Real CPI for wireless fell 48% since 1997

DSL prices fell 25% or more 2004-05

Monthly price for wireless PC card fell 25% 2004-05

Cable modem speeds increased 25-200% 2004-05

Continuous improvement

Real Consumer Price Indices

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

1997 1998 1999 2000 2001 2002 2003 2004 2005

Long Distance

Wireless Phone

Internet

Tel Equipment

Continuous improvement

Real Consumer Price Index, Internet Services

90.00

95.00

100.00

105.00

110.00

115.00

120.00

125.00

130.00

1997 1998 1999 2000 2001 2002 2003 2004 2005

Lock-in

Concept: Inferior technology with higher initial but lower long-term payoff gets entrenched due to network effects or increasing returns

Will policymaking choose best technology? Interest group influence Short political time horizons (election cycle) Policy bundling reduces competitive pressures Limits on decisionmakers’ ability to profit personally Subsidies exacerbate lock-in

Exhibit A: ISDN

Monthly Consumer Cost of Internet Access, 1998

$0.00

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

$80.00

$90.00

$100.00

Dialup ISDN Satellite Terr. w ireless-- MMDS

Terr. w ireless-- LMDS

ADSL Cable modem

Amortized equipment

Amortized installation

Monthly fees

ISDN speed: 128 k

Residential Internet Speeds Available in 1998 (kilobytes per second)

0

500

1000

1500

2000

2500

3000

3500

Dialup ISDN Satellite Terr. w ireless --MMDS

Terr. w ireless --LMDS

DSL Cable modem

On the technology menu …

Wi-Fi Increased cable modem speed/decreased

congestion Increased DSL speed Fiber to the home EDO wireless 400-800 kb Broadband over powerlines Reduced cost of satellite WiMAX

Obsolescence

Long depreciation schedules impractical

Prices must be higher to recover capital costs before competition erodes profit margins

Eg, Balhoff & Rowe estimate 3-5 years to recover capital cost of Wi-Fi

Comparative Risks

Low Risk Avg. Beta High Risk Avg. Beta

Elec Utility 0.72-0.79 Cable TV 1.75

Gas Dist. 0.65 Telecom

Services

1.32

Water Utility 0.60 Wireless

Networking

2.38

Realistic risk premiums?

Spencer, IA City elec utility borrows at 5.75% and makes 4.5% loan to muni comm utility $11.7 million worth of comm infrastructure allocated to electric utility

Cedar Falls, IA 5% on $6 million loan from city elec utility

Lebanon, OH cable 3-5.26% interest rates on bonds

Bristol, VA 3.77-5.99% loans from muni electric affiliate $2 million tobacco grant

Utah 14-city UTOPIA project assumes 6% over 20 years

Balhoff & Rowe estimate true capital costs are 10-13%

Uncertainty vs. risk

Risk: Outcome is unknown, but possibilities and probabilities are known

Uncertainty: Not all possibilities or probabilities are known

Risk can be insured or diversified away, but uncertainty can’t

Shareholders bear uncertainty and must select directors/monitors/managers with good judgment

Can market accountability be replicated? Corporatization with commitment to privatize Public, audited financial statements Transparent disclosure and quantification of

subsidies Clear articulation of expected public benefits Outcome-oriented performance measures Performance and public benefit data as valid

as financial data

Beware of Geeks Bearing Gifts Nothing inherently wrong with advertiser

support or other private subsidies Exclusive access to right-of-way or poles? Right-of-way access is significant barrier to

broadband deployment Assess potential distortion in markets where

firms sell outputs, not just broadband market

Conclusions

Muni broadband may or may not be a good idea

Broadband is subject to dynamic competition

Any sound muni plan should include strategies for dealing with dynamic concerns