WATPA: FW: Business Week - "Behind the High-Speed Slowdown"

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From: Norm Jacknis (norm@jacknis.com)
Date: Wed Sep 18 2002 - 22:45:32 EDT

>From Anthony Townsend at NYU.

-----Original Message-----

SEPTEMBER 17, 2002


      Behind the High-Speed Slowdown

      Sign-up rates for broadband service are stalling. Is it a tech or a
content problem? Neither. It's a pricing problem
The broadband industry is chasing after women like Meredith McGrady. A
28-year-old New York attorney, she's tech-savvy, hip -- and well paid. And
yet, McGrady just isn't willing to pay $50 a month for a high-speed Internet
connection. She's online all day at work. At home, she mostly uses the Net
to check e-mail. And for that, a dial-up connection does the job just fine.

In a microcosm, McGrady is what's holding back the broadband industry -- the
cable-TV outfits and phone companies that sell access to the Internet at
speeds of roughly half that of a typical corporate T-1 line. Over the past
five years, some 9 million subscribers have signed up for cable modems, and
an additional 4 million are using DSL (digital subscriber line) access that
telecoms sell.

Yet now, the industry is at a crossroads. Just as broadband signups are
about to reach critical mass, their growth is starting to slow -- to perhaps
4 million new customers in 2002, vs. 5 million each in 2001 and 2000,
according to ARS, a technology research company in La Jolla, Calif.

NONSTOP INCREASES. In large part, it's a contrived slowdown, in which the
providers of fast Net access have tested the elasticity of demand by raising
prices until consumers balk. In this year's second quarter, the cost of
high-speed links finally leveled off after 15 months of nonstop increases.
As of June, the average price for cable-modem service was $45.31 per month,
up 15% from $39.40 a year ago. DSL service from local phone companies rang
in at $51.36 a month, up 7% from $47.84 a year ago.

The price differential helps explain why cable companies held 62% of the
broadband market as of June, vs. 35% for DSL and 3% for nascent satellite
and wireless services. (Another factor is that cable-modem connections are
available across more of the country.)

Clearly, broadband operators could sign up more customers if they wanted to
cut prices. But for now cable companies are happier with higher operating
margins -- 35% to 45% on their modem services -- than with scads of new
customers. On the other hand, phone companies that provide DSL are having a
hard time making it profitable, so they're not as aggressively pushing the

      "If growth starts slowing down, then a tiered product becomes a

Still, cable-modem and DSL subscriptions continue to grow on average at 12%
and 11%, respectively, per quarter -- a remarkable figure during a
recession. With nearly 50% annual growth at current prices, cable companies
see little reason to try luring low-end customers -- even with tiered
pricing plans that charge less for slower service. "The reason that tiered
pricing has been slow in coming is because of the robust growth of the
flagship product," says David Pugliese, vice-president for advanced data
products at Cox Communications (COX ), the nation's No. 5 cable operator.
"If growth starts slowing down, then a tiered product becomes a priority."

CHICKEN OR EGG? While the cable kings are maximizing profitability,
politicians and struggling telecom companies are in a tizzy over what they
see as a technology tragedy: A nation not sufficiently hooked on broadband.
"For high-tech industries and the American economy, bringing on the
broadband boom can spark the next sustained surge of economic growth,"
intoned Senator Joseph Lieberman (D-Conn.) on May 28 before introducing the
"National Broadband Strategy Act of 2002," which would require the Bush
Administration to come up with a plan to increase high-speed usage within
six months of the bill's passage.

The theory behind Lieberman's thinking and that of others who support such
initiatives is that wider use of broadband would fuel the next stage of
Internet innovation: delivering real-time video, music, and other services
yet to be imagined directly to American homes and businesses. All told, some
30 bills that aim to speed broadband deployment -- usually, by subsidizing
rural rollout -- have been introduced in the House and Senate this year

In most cases, those proposals suffer from the misconception that broadband
has been crippled by a chicken-and-egg dilemma. Customers have stopped
flocking to fast access, the thinking goes, because of a dearth of
must-have, bandwidth-intensive applications, such as downloadable movies and
easy-to-use music-subscription services. And the reason such services don't
exist, according to this theory, is that too few customers have signed up
for broadband for big media companies to warrant the heavy investment that
such programming requires.

SIMPLE SELLS. What's missing from this theory is a little analysis.
Historically, communication has been far more prized than content. Annual
movie-ticket sales in the U.S. are well under $10 billion, notes Andrew
Odlyzko, director of the Digital Technology Center at the University of
Minnesota and author of a 2001 paper "Content Is Not King." Phone companies
collect that amount every two weeks.

Nor has content been the key draw in the Digital Age. AOL users spend most
of their time using e-mail and chat rather than the packages of
entertainment, news, and shopping information that AOL offers. Cell-phone
users have enthusiastically embraced short text messages but have rebuffed
wireless application protocol (WAP) "content services," such as weather and
news updates and stock quotes. "Simple connectivity and communication
services attract much more spending than 'glamorous' content," says Odlyzko.

      Low prices have spurred a broadband boom in Korea

For real-world proof that price -- not content -- is the culprit, take a
look at Korea. More than 50% of households there have a broadband
connection, compared with just 12% in the U.S. That's because, in the
mid-1990s, the government forced the country's phone monopoly, Korea
Telecom, to open its network to competition. The intense price wars that
ensued dropped the cost of all-you-can-use service to as little as $25 a
month -- or about the same as for a pokey dial-up line. The result: Over the
past three years, the number of broadband subscribers in Korea has surged
from a few hundred thousand to 8.5 million.

WARY FOLLOWERS. That in turn has spurred the introduction of new services
such as those Washington pols envision, not the least of them online video
games. Korea now has more than 26,000 PC baangs, or Internet game rooms,
where young people gather to compete in multiplayer shoot-'em-ups, check
e-mail, or find a hot date. "The Korean case shows there's a point where
content becomes a driver. But the leap from dial-up to broadband depends on
other things -- namely price and the ability to keep your e-mail address,"
says Jed Kolko, an analyst at Forrester Research in Boston.

Broadband providers in the U.S. are wary of following the Korean model for a
variety of reasons. Cable operators would rather not mess with success. And
phone companies fear that even if they did attract more customers, it might
hurt the bottom line. Since one phone line can handle both voice and DSL
service, a customer who switches to broadband might cut off a second
residential phone line that had been used previously for an Internet
connection. Though customers pay more for DSL than for regular lines, DSL
technology is far more expensive to install and maintain. Plus, its gross
margins are slimmer.

Still, realizing that they need to be prepared to stimulate demand, cable
and DSL providers are slowly beginning to experiment with multiple pricing
schemes: The slower the speed, the lower the price. On Aug. 21, SBC
Communications (SBC ) announced that it would offer six tiers of DSL service
to help draw in more subscribers. Atlanta-based Cox (COX ) is pilot-testing
a slower-speed service in Las Vegas for $34.95 a month. For nearly two
years, Denver-based Charter Communications (CHTR ) has offered tiered
pricing that starts as low as $29.99 per month.

VANISHING MARGINS. The trick will be to offer such wrinkles while
preserving margins. Researcher Yankee Group estimates that the average
monthly operating cost per cable-modem customer, which includes billing,
maintenance, data-transport fees, and network management, totals $15 to $23.
At $45 per month, cable operators' operating margins are 35% to 45%. If the
price of an always-on connection dropped to $25 or $30 a month, those
margins would essentially evaporate.

"It costs us the same amount to provide a high-speed or a low-speed"
broadband connection, says one cable executive who requests anonymity. "When
we look at the capital, maintenance, and network-management costs, a person
who pays $25 and a person who pays $45 don't look very different. We need to
do what's right for the business." That's why broadband operators worry that
customers who currently pay $45 per month might downgrade to lower-priced,
lower-profit tiers.

      Charter has found that many of its low-tier customers soon upgrade

At least some evidence, though, indicates that such fears are unfounded.
Charter Communications, the tiered-pricing pioneer, reports that although
60% of its customers sign up for its lower-tier service, many subsequently
upgrade. Moreover, the tiered pricing clearly appeals to customers: Charter
has recorded quarter-over-quarter subscriber growth of more than 20% in nine
out of the last 10 quarters, according to ARS Research. This hasn't hurt its
margins. In the second quarter, operating margins for cable-modem services
were 53%.

BUILD YOUR OWN? Ultimately, broadband providers may have no choice but to
lower prices -- because of competition. Already, a company called Wide Open
West in Castle Rock, Colo., offers broadband for as little as $19.95 a
month -- less than the cost of the AOL service over dial-up -- in select
areas in Illinois, Indiana, Michigan, and Ohio.

Municipalities throughout the U.S. are also building their own fiber
networks. One is Bristol, Va., a town of 18,000 on the Tennessee border,
which has built a $3 million fiber-optic network to provide high-speed
Internet access to local residents. The small population means users get
rocket-fire speeds up to four times as fast as traditional broadband

Don't expect the interlopers to make much headway soon, however. So far,
incumbents such as Verizon (VZ ) have succeeded in persuading 10 state
governments to limit the freedom of municipalities to provide telecom
services, including broadband -- or prohibit them from doing so altogether.
In fact, Bristol was able to proceed only because it won a court victory
overturning the state law that banned local telecom services. And the
Virgina state government is appealing the decision.

MASTERFUL DEAL. Instead, new growth will likely come from marketing
agreements that broadband providers are beginning to strike with traditional
Internet service providers, such as America Online and Earthlink. In August,
Comcast cut a masterful deal with AOL, under which AOL is said to pay AT&T
Comcast $35 per month per broadband subscriber, along with a cut of
advertising, e-commerce, and other revenue. Comcast's pending merger with
AT&T Broadband will make it the country's leading broadband operator, giving
it more leverage to negotiate than most.

But if other cable and DSL providers can extract similar terms, such deals
could lure millions of new customers to broadband by making it easier for
them to switch -- and, most important, to keep their beloved e-mail
addresses. "It's a brilliant deal," says one senior cable executive. "It
will spur other deals forward -- and that will expand the market."

For now though, in the broadband world, price is king. And as long as that's
true, the growth of broadband won't accelerate to warp speed.



By Jane Black in New York

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