The Case For Municipal FTTX

Avoiding franchise rules while preserving exclusivity in wired communities.   June 2005

In last month's issue, we presented "The Case for Municipal Broadband," outlining the rationales for municipal involvement in broadband generally and refuting the arguments used by cable and telephone company lobbyists against such involvement as the question is debated in state legislatures.

In this article, we assume that there is a sound rationale for municipal broadband generally, and we focus on why fiber optics is the optimal last-mile network solution for municipal broadband particularly. We refer to this solution as fiber-to-the-X, or "FTTx," to encompass a variety of fiber-based architectures including fiber-to-the-home, fiber-to-the-curb, fiber-to-the-premises, fiber-to-the-business, fiber-to-the-node, and so on.

Outlining The Problem

The world economy generally, and the American economy specifically, are today based on knowledge, the gathering and dissemination of accurate and up-to-date information. Given the importance of communications technology in our knowledge-based economy, communities without affordable access to the latest broadband services can expect to be left ever further behind as the rest of the world rushes into the information age. While a few years ago, a lack of advanced communications infrastructure might have presented an inconvenience for a small number of "techies," today it amounts to a general deficit affecting all aspects of the deprived community, including education, social services, health care and overall economic viability.

More and more municipal planners say that broadband networks are about to become what roads, electric systems and the telephone network are today: Part of the core infrastructure of society. This is why the federal government has unequivocally declared universal broadband access to be a crucial national priority. In March 2004 President Bush said, "This country needs a national goal for ... universal, affordable access to broadband by 2007."

But grand policy declarations are one thing, and implementation is another. The Telecommunications Act of 1996 was supposed to produce more competition, lower prices, more jobs and a booming economy. Instead, the nine years since its enactment have seen dramatic rises in cable television and local telephone rates, huge declines in the market value of telecommunications firms, and (by 2003) the loss of about one-half million jobs.

In lieu of competition, the 1996 Act has stimulated an unprecedented wave of mergers, allowing a small handful of monolithic media giants to control both the information that is disseminated to the public as well as the means of dissemination. Congress has begun working on a comprehensive re-writing of the '96 Act, which, fueled by industry campaign contributions and lobbying efforts, promises even more deregulation in the future.

Nor has deregulation stimulated investment in the deployment of broadband infrastructure at the levels promised both by the media giants and the FCC. Among developed countries, the United States ranks poorly in broadband deployment, and is losing ground. It appears that during 2004, America slipped from thirteenth to sixteenth in broadband deployment nationwide, and even where high-speed connections are available, they are significantly slower than those available in many countries. For example, while American DSL and cable modem connections fall in the range of 1 to 5 Mbps downstream and 50 to 300 Kbps upstream, most consumers in South Korea and Japan have access to 30 to 100 Mbps symmetric capabilities.

As these numbers suggest, America's strategy for achieving its policy goal of universal broadband access is deeply flawed. The flaws are expressed by data describing the so-called "digital divide;" America's global standing in the area of broadband deployment is primarily based on the fact that huge swaths of our country remain under-served or not served at all.

Recent studies suggest that fewer than one-third of Americans have access to broadband services. The latest National Telecommunications and Information Administration (NTIA) "A Nation Online" report indicates that only 20 percent of households had "high-speed" Internet access as of 2002, and more recent data shows an increase to around 30 percent in 2005. Within that 30 percent, the deployment of broadband facilities is distributed around clear geographical and demographic axes, with the vast majority of high-speed connections leading to wealthier urban and suburban consumers. Moreover, where broadband services are available, most consumers have only a limited choice between a single cable modem and a single DSL provider at prices that reflect the lack of effective competition.

But if America is lagging behind in the global race to broadband, the situation is exacerbated by the fact that the finish line is receding. The concept of "broadband" itself is quickly evolving, as an entirely new generation of services and applications, requiring symmetrical data transmission capabilities of 10 Mbps or more, are rendering the FCC's definition (200 Kbps in either direction) obsolete.

Application and content designers aren't sitting on their hands waiting for cable and telephone companies to invest in Iowa, and the next wave of broadband services will involve comprehensive bundles of interactive digital video, data and telephony delivered to those with connections capable of handling the required bit volume. Provisioning of "triple play" broadband services requires a transmission capability of at least 30 Mbps (preferably 50 Mbps where digital television is delivered to multiple sets in a home), and therefore, significant upgrades of the currently existing infrastructure even in most areas where high-speed connections currently exist.

Why Fiber?

From an ideal perspective, the preferred method of opening up the last-mile bottleneck is to extend fiber optic strands all the way to the end-user's premises. More than any other infrastructure technology, optical networks can unlock the potential of next-generation mass-market communications services for the foreseeable future. Networking guru George Gilder a decade ago described the transmission capacity of fiber optics as follows:

The bandwidth of one fiber thread could carry more than 2000 times as much information as all [the] radio and microwave frequencies that currently comprise the "air." One fiber thread could bear twice the traffic on the phone network during the peak hour of Mother's Day in the United States (the heaviest load currently managed by the phone system).

In the ten years since this was written, fiber optic technology has evolved to the point where even Gilder's seemingly hyperbolic assessment is an understatement. Fiber connections offering 10 Gbps or more are already being marketed, providing a theoretical capacity of 100 terabits per second (2.5 billion times faster than dial-up) – bandwidth that is, for all practical purposes, unlimited. Due to their huge capacity, technical flexibility, low maintenance costs, and lack of legacy allocations, fiber optic networks provide a "future-proof" solution to the last-mile bottleneck problem. In the future, almost all communications – such as interactive television, distance learning, telemedicine, motion picture–quality videoconferencing, videophones and various peer-to-peer (file-sharing) applications – will employ fiber optics over the last mile.

Why Municipal FTTx?

There is no doubt that FTTx deployments are gaining ground, and quickly. By April, almost 1.9 million U.S. homes were passed by fiber-to-the-premises (FTTP) networks. According to In-Stat's market research, that figure will jump to 11.8 million by 2009. As highlighted in this issue of Broadband Properties, Fiber Optic Communities of the United States (FOCUS) reports that as of April 2005, there are 398 FTTH communities in the United States, an 83 percent increase over the past year.

The primary drivers of the FTTx push have been the ILECs defensively rolling out neighborhood fiber to avoid losing broadband customers to cable in next-generation video markets. SBC has committed $4 billion in capital expenditures to fund Project Lightspeed, deploying fiber-to-the-curb (FTTC) to deliver bundled packages of VoIP, high-speed data and IPTV to 17 million homes by 2008. Verizon deployed FTTH to 1 million homes last year and plans to pass twice as many in 2005 to market its FiOS ("fiber optic services") product in selected areas across the country.

Although ILECs such as Verizon and SBC Communications are driving the FTTx push, municipalities also play a crucial role: CIR analysts concluded in 2003 that due to uncertainty affecting investment by the private sector, municipalities, rather than ILECs or cable operators, will drive growth of the FTTx market in the near to middle future. That was before the Supreme Court ruled that states could curb municipal appetites for fiber, but municipal systems continue to be built.

Private Sector FTTx

To understand this phenomenon, we need to understand the respective public and private sector incentives for broadband deployment. As explained in my previous article, "The Case for Municipal Broadband," there are two primary drivers of municipal involvement in broadband provisioning.

The first is market failure – the historically and logically demonstrable failure of private cable and telephone companies to invest in areas that do not meet specific geographic and demographic criteria revolving around the need to recover a return on investment and turn a profit as quickly as possible. Communities in rural and or lower-income areas are faced with the choice of waiting for vague and unreliable promises of universal service to be fulfilled, or of taking the initiative in deployment, either alone or in partnership with private firms. An ever-increasing number of municipalities are choosing to self-provision broadband infrastructure, at least where state law is not being used to undermine their initiatives at the behest of the large cable and telephone incumbents.

The second important rationale for municipal broadband is the need for economic development: The existence of a robust communications infrastructure is seen as the key to a community's ability to attract and retain new business investment.

Therefore, judging the legitimacy of municipal FTTx initiatives requires an honest and informed evaluation of the prospects for private sector deployment of last-mile fiber solutions. This is a complex subject that produces wildly differing opinions among the best minds at the FCC and Wall Street, among others. We can at least sketch the dynamic here.

Fiber optic cables are long-lived and costly to install, although the cost of equipment is falling. Current estimates of the costs of FTTH deployment range from id="mce_marker"000 to $2000 depending on the particular network architecture being used and the physical environment where the deployment occurs. In order to cover plant costs and the cost of electronics from subscriber revenues (in five years with an IRR of 20 percent), a provider needs a penetration rate of about 35 to 40 percent.

Given the high capital costs of FTTx deployment, deployment by the private sector has been spotty. In particular, the telephone companies have until recently been slow to deploy high-capacity fiber-optic facilities in residential neighborhoods, presumably because they have relied on revenues from second residential copper lines used for dial-up Internet access.

Likewise, cable operators have been slow to deploy fiber networks due to cost and the fact that their existing hybrid fiber-coax plant can be upgraded to support most applications currently being mass-marketed to consumers. Only in the mid-1990s, when cable companies began mass-marketing their cable modem services as an alternative to the dial-up Internet, did the telcos become seriously involved in spending the billions of dollars needed to upgrade their copper loops to provide broadband capability via DSL. Although DSL is always provided over copper lines, extending fiber into local neighborhoods decreases the amount of copper required, and thereby (because DSL is distance-sensitive) increases the number of DSL-capable locations, and expands the bandwidth of available DSL connections.

The telcos were given a boost in 2003 when the FCC's Triennial Review Order eliminated section 251 unbundling obligations for ILEC packet switches and curtailed such obligations in FTTP and FTTC loops in greenfield (i.e., new build) situations. Despite the fact that the ILECs are released from the requirement to share their fiber-based facilities with competitors, the required multi-billion dollar investment remains a huge gamble, and some analysts remain skeptical. Scott Cleland, for instance, opines, "Bell fiber announcements are much more about maintaining perceptions of a better future than the reality of a better future."

This is not to deny that some of the large cable and telco incumbents are proceeding with very ambitious plans to upgrade their networks by pushing fiber deep into residential neighborhoods. The fiber push is seen as a business necessity from each side as the telephone companies seek to compete with cable for high-definition video markets, and the cable operators ride VoIP into the voice telephony markets. We have mentioned in particular the Verizon and SBC initiatives, but even these ambitious rollouts leave critics wondering if the incumbents are cherry-picking their investment targets, focusing only on wealthier communities where they can market their triple-play bundles at higher prices. For example, a recent report published by Multichannel News indicates that the first 55 communities chosen for Verizon's FiOS project have a median household income of $81,920, almost twice the national average of $41,994. Furthermore, both Verizon and SBC are actively seeking ways to avoid local franchising requirements for their video products, including the requirement that they offer service to all residents in the franchise territory. For example, the Texas legislature recently rejected a bill urged by Verizon and SBC that would have allowed the phone companies to seek statewide (in lieu of local) franchises to offer cable TV programming over their newly deployed FTTx networks. Lawmakers apparently agreed with the cable companies that a statewide franchise would allow the telcos to sell their services only in affluent areas, but this battle will continue to be waged in other states, starting with New Jersey.

Regardless of whether the critics' concerns are justified, the bottom line remains the bottom line. Service providers are forced to invest in excess capacity ahead of current demand, or to tolerate congestion until demand bubbles over into investment in the next increment of capacity. FTTx presents the private sector with a chicken-or-egg dilemma: without high-capacity infrastructure, next-generation services cannot be designed, developed or marketed. But without the new services, there is insufficient demand to justify the huge capital costs of infrastructure deployment. The result is that FTTx deployment by private firms (even more than DSL and cable modem deployments) focuses on wealthy, concentrated areas, where return on investment is less affected by uncertainty and delay, leaving less developed, rural areas to their own devices. The National Rural Telecommunications Cooperative estimates that fewer than 10 percent of homes on rural America have broadband access.

In addition to the demographic and geographic issues, municipalities contemplating FTTx self-provisioning must consider the economic likelihood that even in FTTx markets likely to be served by the private sector, the prospects for effective, facilities-based competition, and thus for competitively priced triple play products, are highly uncertain.

Again, installation of fiber involves large initial outlays for fixed costs; therefore, it makes economic sense to install substantial excess capacity. Much of the sunk cost stems from the installation of conduit and associated trenching, and these costs are not significantly increased by the placement of multiple fibers. Combined with the de minimus cost of transporting one more unit of use (marginal costs), the high fixed costs of deploying fiber create marked economies of scale.

The economies of scale associated with fiber-optic networks dictate not only that deployment will be focused on high-density markets, but also that such networks have natural monopoly characteristics. That is, as marginal costs approach zero, effective competition would push prices, and therefore profits, toward zero as well. In this circumstance – with excess capacity built into networks characterized by low marginal costs – consolidation among providers is a likely result, absent active government intervention. Given that government intervention is unlikely in the United States (where, as mentioned above, the FCC has recently de-regulated ILEC FTTH loops), many commentators have concluded that FTTx markets will likely be monopolized.

Municipal FTTx

While the deployment decisions of private firms are always based on the criterion of profitability, the decision-criterion for municipalities is public service on behalf of residents of the local community. Because the incentives are fundamentally different, the economic considerations underlying a municipality's decision to deploy FTTx networks are also different. Recovery of operating costs replaces profitability as the primary economic necessity driving municipal broadband – a crucial point that is generally ignored by critics who, in various published studies, simply assume that the business case for municipal broadband must be the same as that underlying private networks.

A public network is successful if it provides quality service to residents at affordable prices while paying for itself. The tangible benefits of a successful municipal broadband network accrue not in the form of monetary profits distributed to shareholders living in far-away places, but as an array of positive externalities ("synergies") that grow like mushrooms in and around the local community by virtue of having access to cutting-edge communications services and facilities. While local taxpayers must foot the bill for the initial investment in infrastructure, the community's wealth-generating capacity is greatly enhanced by being able to offer existing and potential individual and organizational residents services like telemedicine, broadband-wired schools and universities, telecommuting, and business opportunities that would not otherwise exist.

Communities with municipal electric utilities (MEUs) often choose to deploy FTTx networks because the utilities have already invested in fiber optic infrastructure to support their electric service; this infrastructure can be upgraded to support advanced communications services using existing rights of way and easements. And because municipalities have little incentive to leverage monopoly control over infrastructure, the open access model is a more natural fit for public networks than it is for proprietary networks.

"Open access" in this context simply means a network architecture that permits multiple service providers to share access to local transport facilities at the data-link layer. Due to the high and mostly fixed and sunk costs of deploying fiber, and its extremely high transmission capacity, it makes sense for municipal FTTx projects to permit multiple providers access to the facilities on a wholesale basis. A private/public partnership allows local government to limit its participation to that of building, owning and maintaining the neutral fiber transport facilities, without the responsibility of monitoring quickly evolving developments in the electronics industry. Private sector broadband service providers offering VoIP, IPTV, and high-speed data products benefit from not having to finance their own transmission facilities, and consumers benefit from service level competition in being able to choose among providers.

Conclusion

If market failure in the private sector explains municipal involvement in broadband communications generally, the two aspects of market failure described above – the likelihood that areas not meeting the geographic and demographic criteria for private investment will remain underserved, and the likelihood that even in areas targeted for investment will be monopolized – provide the rationale for municipal FTTx initiatives in particular.

It is not surprising, therefore, that dozens of communities all across the nation have decided to head off private sector market failure by publicly funding their own FTTx networks. These communities, some of which (including Provo, Utah, Project UTOPIA in Utah, Cedar Falls, Iowa among others) have been described in these pages over the past year, have decided that deployment of a future-proof communications infrastructure is worth the economic risk now, because access to the most advanced broadband services is the key to their economic viability in the future.