A gathering storm?

Anyone who has visited China recently will remark on the number of huge infrastructure projects underway in the country. Multi-lane expressways, high-speed railways, citywide metro systems – and invisibly running alongside them, China’s fibre-based communications infrastructure of the future, connecting the breathtaking skyscrapers, monstrous factories, luxury shopping complexes and new apartment block cities. Not-so-invisible microwave and cell towers provide 100% coverage even on the top of China’s highest mountains and in remote towns, with citizens of villages set to enjoy the same broadband speeds as those living in city centres. The People’s Republic does seem to understand and embrace the concept of universal broadband and it is taking advantage of its massive, ongoing building programme to ensure this is delivered.

Of course, there are downsides to centralised planning on such a scale and most citizens of western countries would prefer to continue with a democratic, market-driven approach to bandwidth provision – even when it results in the polarisation of views that is currently tying the US telecoms industry up in knots.

Lack of capacity in US local access networks is at the heart of the net neutrality debate and, according to some commentators, is creating a nation of broadband haves and have-nots. Some, like Hunter Newby, CEO of Allied Fiber, warn that economic growth in the US will be severely damaged unless there is more investment in telecoms infrastructure in general, both local and long distance. But no one can agree what to do about capacity constraints in the last mile: indeed, opinion is sharply divided over whether anything needs to be done at all.

The Federal Communications Commission (FCC) is on the side of more industry action, citing the fact that between 14 and 24 million Americans still lack access to broadband internet connections. Its National Broadband Plan, submitted to Congress in March, outlined proposals for connecting all US citizens and providing high-speed access of at least 100Mbps to 100 million US homes. The FCC estimates that it will cost around $320 billion to enact the Plan – but the money will need to come from the pockets of telcos and their customers, rather than from the government. The FCC expects to pave the way for this investment with a raft of reforms, including an overhaul of the allocation and management of assets such as spectrum, poles and rights of way and changes to the Universal Service Fund.

While many alternative operators would welcome a more streamlined and fair rightsof- way regime – “We would like to see the FCC announce more meaningful standards that prevent state and local authorities extracting outrageous rights-of-way fees," comments John Ryan, Level 3’s head of regulatory affairs – others believe the Plan will have limited success in encouraging the competitive investment that will challenge incumbent local exchange carriers (ILECs) in their local markets.

Charlie Reed, senior analyst at Atlantic- ACM, points out that ILECs have around 85.5% of the US local access market and he expects this to drop by a mere three percentage points to 82.5% by 2015. Reed says that the ILECs’ minor losses will mainly be cable companies’ gains, since the latter are taking advantage of their proximity to cell towers to move into wireless backhaul. “Competitive local exchange carriers (CLECs) will never have the money to build out access as comprehensively as ILECs, so this situation will not change significantly,” Reed points out.

Indeed, some pundits lay the blame for the fact that the US does not already have world-leading broadband connectivity at the door of the FCC and there is considerable scepticism that it will be any more successful at encouraging “universal broadband” this time around. After all, as the first market to regulate, the US was also the first market to promote local loop unbundling (LLU). Jose Manuel Mercado, senior analyst at Pyramid Research, points out that the first unbundling requirements for ILECs, (known as UNE or unbundled network element) were mandated by the Telecommunications Act of 1996.1, in which the FCC’s regulations were the most rigorous in the world.

Unfortunately, they were also sufficiently unspecific that the ILECs could easily dispute them, miring LLU in legal disputes for the next eight years. “At the end of 2004, the FCC redefined and reduced the unbundling obligations for ILECs [known as unbundled network element-platform or UNE-P] and the ILECs gained considerable freedom to determine the local loop price. The pricing and cost benefits were simply not there for alternative carriers,” Mercado explains. “In the meantime, other technologies are emerging that allow operators to bypass regulation so participation in LLU is decreasing.” The FCC had hoped that resale and UNE would be interim local access solutions, which would allow CLECs to generate sufficient income that they would eventually be able to invest in building out their own facilities. The collapse of UNE-P has definitively undermined this goal and Mercado concedes: “The US consumer is losing out.”  

Fixed-to-mobile substitution may be seen as the latest route to providing the US consumer – and businesses – with competitive broadband services, but a large component of mobile service pricing is the cost of backhaul, which in turn, depends on the price of last mile circuits connecting aggregation points to the cell towers. As AT&T CEO Randall Stephenson noted in an August interview with Fortune magazine: “What has been the biggest obstacle to getting the bandwidth required for iPhone penetration in a city like New York? Spectrum is important, but the number one issue is getting fibre to these cell sites. That’s where the bottleneck is.” Cell towers need more fibre connectivity if 4G networks and fast mobile broadband services are successfully to fly and the challenge remains: how to put in place a fit-for-purpose regulatory regime that encourages all players, including ILECs and CLECs, to invest appropriately in the access network, giving them a fair return on their investment. At present, an ILEC may have between 85% and 99% of any given local access market.

Competitive incentives to change this are weak while the barriers to investment are, for many, still too high. “Even when a large wireless carrier comes with a proposal to build out to all its cell towers in an area where we are strong in the market, the payback is in the four to five year range. This holds us back where large-scale build-outs are concerned,” remarks Paul Savill, Level 3’s SVP products. 

So most of the market has no choice but to depend on incumbent-owned last mile access, including so-called, high-speed “special access” circuits. Alternative carriers say the ILECs’ largely unfettered behaviour towards special access pricing is increasingly monopolistic. Don MacNeil, VP carrier service operations at XO Communications, describes the fact that the largest ILECs, and particularly AT&T, are pushing up prices as “a point of contention in the market that will affect a lot of people”. Spearheading opposition to the ILEC’s stranglehold over special access is the No Choke Points organisation, set up by Sprint and Clearwire, which also numbers among its members Cbeyond and BT. Level 3 has not joined the No Choke Points coalition, but Ryan says the company has become aware in the past year just how insidiously special access arrangements affect its business and act as a disincentive for last mile investment.

Many of the ILECs operate volume and long-term discount plans – loyalty schemes that effectively lock in their customers, according to one carrier who asked not to be named. “The only way a CLEC can get a significant discount off the rack rate, in order to offer a competitive price to its customers, is to agree to buy 90% or more of their volume year-on-year from the ILEC. So when a competitor turns up, it seems like there should be a lot of demand in the market, but the addressable demand is only around 10% as the ILEC has the rest of it locked up.”

Ryan believes the FCC could, and should, address the problem of anticompetitive terms and conditions and reinstate regulation that sets price caps for special access circuits in uncompetitive markets. He argues that such moves would encourage investment in competitive facilities – the original goal behind the FCC’s LLU regulation. Encouraging facilities-based competition – as opposed to reseller competition based on the same, underlying, ILEC-owned infrastructure – is good for the market: “If there’s one thing we’ve learned in the past 10 years, it’s that facilities-based competition is much more resilient than reseller competition,” Ryan remarks. 

Ranged against the voices in favour of the National Broadband Plan are the rural operators, those most likely to be affected by new Universal Service requirements, and metro carriers with successful rights-of-way strategies. They argue that the industry doesn’t need to be pushed into providing large amounts of capacity that consumers don’t want to pay for and don’t need. In fact, many metro carriers are decidedly unsympathetic to any suggestion of regulatory change, sitting as they are so prettily under the current regime.

They are far enough away from the sharp end of the value chain not to feel the pressures that CLECs are under, ILECs are their best customers and their facilities-based businesses are built on an appreciating and much sought-after asset, dark and lit fibre. These factors are pushing up their market valuations and more fibre-based competition is the last thing they want. “We are experiencing a vibrant market with strong revenue growth and profitability. The competitive environment is appropriate – it’s balanced and not overly competitive,” comments Zayo’s CEO, Dan Caruso.

Michael Miller, CEO of Fiberlight, worries that such a comfortable level of competition may change as “cable companies become more aggressive, moving upmarket into enterprise and wholesale markets and acquiring CLECs” – a reference to Comcast’s purchase of Cimco last year – while regulation that allows municipalities to build their own networks “is a competitive threat to companies that have invested millions of dollars in a particular city market”. Bill LaPerch, CEO of Abovenet, nevertheless believes that asset-based companies like his can stay strong “regardless of the regulatory environment,” especially as metro operators consolidate to build scale and extend their geographic reach. 

Such is the attractiveness of the metro player, with its modern fibre network and potential to provide competitive local access in key markets, that an M&A boom is underway. “There’s more metro selling activity than we’ve seen for five or six years – everyone is for sale at the moment,” LaPerch remarks. “We expect around 50% of companies to be acquired, although there is a difference at the moment between their asking prices and what buyers are willing to pay.” As private equity interest in metro operators ramps up, so too do the prices.

Caruso believes that a consolidating market will result in a mere eight to 12 US players owning fibre in the future: Zayo, one of the most aggressive deal-makers of the past few years, plans to be one of them. But Caruso is keenly aware of rising competition: “We know every property for sale out there and in the most recent four or five deals, others have bid more than we were prepared to,” he says. Lexent fell to Lightower Fiber Networks in September, while Zayo also lost out to Windstream, which successfully bid for Kentucky Data Link in August. As Caruso points out, however, the larger the metro players get, both organically and through acquisition, the better they become at attracting and serving bigger customers, including international carriers, and the more investment they can then make in extending their networks. “We have a large capital programme underway to take us to new locations,” Caruso says.  

Meanwhile, XO’s strategy for beating the fibre shortage in the local loop is to roll out Ethernet over copper: "We’re deploying it like gangbusters,” MacNeil says. “It’s a great complementary technology to plug into our MPLS and IP/VPN services and we’re having a lot of success with the reseller community that got displaced when UNE-P went away. The word is also beginning to get out to international carriers that they can use our MPLS and Ethernet access services instead of building out their own networks.” MacNeil says only 15% to 20% of US buildings have fibre connectivity, opening up an opportunity to sell up to 20Mb Ethernet over copper access.

But for Newby, getting more fibre to the market is key. “Everyone wants dark fibre – XO doesn’t have it, Level 3 won’t sell it, nor will AT&T or Verizon. On the routes everyone wants, there is no dark fibre available to purchase on a long-term basis,” he points out. “The US has a lot of Tier 3 and Tier 4 cities – how do they grow if there are only one or two providers of backhaul transport and there’s no dark fibre available?”

Allied Fiber’s answer is to build out the carrier-neutral fibre backbone to which it hopes new on-ramps, such as municipal or commercial 4G networks, will attach themselves. Since Newby despairs of political answers to the “universal broadband” problem – slating the federal broadband stimulus programme for the small ($7.2 billion) sum of money involved and lack of a co-ordinated implementation plan – he is counting on the US tradition of self-help to bring high-speed connectivity to the people. Allied Fiber wants communities and local governments interested in investing in their own local access networks to come forward, apply the Allied Fiber model and link into its backbone. “Together, we’ll create a system across the country and let the willing come,” Newby insists. Allied Fiber’s way will take longer than the Chinese way but it is a beacon in a market where competition and regulation has so far failed, universally, to deliver.

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The Verizon-Google legislative framework

Two further regulatory hot potatoes with potential to derail the FCC’s National Broadband Plan are its efforts to reclassify broadband as a “Title II” telecommunications service, therefore subject to FCC regulation, and net neutrality. The issues are interlinked, with the proposal to reclassify broadband sparked in part by the FCC’s legal trouncing by Comcast over Comcast’s 2008 attempt to throttle P2P services, against the spirit (though not, it turned out, the letter of the law) of net neutrality. Comcast claimed, successfully, that the FCC had no power to sanction it and the FCC’s reclassification proposal is its way of fighting back. Carriers of all stripes are unhappy with the idea of internet reclassification and in many ways, the Verizon-Google Legislative Framework Proposal, a bold bid to break the net neutrality deadlock, is a pre-emptive strike against it. Altnets point out that AT&T and Verizon are exceptionally adept at fighting telecoms legislation and have the firepower to do so: the Telecommunications Act of 1996.1 is a case in point. “We believe that the threat of regulation is a more meaningful deterrent to bad behaviour than regulation would be,” comments Level 3’s John Ryan, who welcomes the “industry leadership” that Verizon and Google have shown and sees “a lot to praise” in their proposal. While a number of the elements within the Verizon-Google Legislative Framework Proposal are non-controversial and echo the Four Freedoms the FCC first articulated in 2004, its point about Additional Online Services concerns some wholesale carriers. The Framework appears to advocate the establishment of multiple “internets”, a public, “net-neutral” internet and private internets which providers could shape as they wish. In many respects, de facto “private internets” already exist, with some carriers running public and private IP networks in parallel. The exact nature of an additional online service – and how it would differ from the public internet – has yet to be defined but some  operators worry that ILECs would use their end-to-end control of access and core networks to provide anti-competitively priced private internet services. Yet at the same time, the industry recognises that unless ILECs are safe from the fear of net neutrality regulation, they have little incentive to boost capacity in the access network. “If you gave me a choice of two worlds five years from now, one with a net neutrality mandate where everyone has 5Mbps of capacity and the edge providers are compelled to deliver all packets equally and one with no mandate where 50Mbps of capacity is generally available, I’d pick the second,” Ryan says. “Discrimination is only an issue because there is not enough capacity at the edge and carriers need carrots as well as sticks to build it.”