Sunk costs support sinking gigabit prices

6 October 2013 by Steve Blum
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Nowhere to go but up.

Fiber-to-the-home system operators are falling in behind Google’s idea that market share counts more than marginal revenue gains (or cost controls). Both Chattanooga’s municipal FTTH network and the Utopia system serving several Utah communities are following Google’s lead in Kansas City and Provo, and offering residential gigabit service for monthly fees in the $65 to $70 range.

At $350 per month, Chattanooga was attracting only a few dozen gigabit-level subscribers. At $70 per month, it should shortly have tens of thousands. For now, almost all of those will be existing subscribers who will upgrade in place. Over time, though, it’s a way of leveraging the cheap and abundant bandwidth provided by an FTTH system to gain market share.

Although reliable subscriber and market share figures are hard to come by, it looks like Chattanooga’s muni fiber system might have as much as 30% of local Internet subscribers, and Utopia appears to be in the 15% to 20% range. In either case, it’s not enough to pay back the full cost of building the systems, including debt service. I’ve yet to see hard numbers that show that it’s even enough to cover the true operating costs.

But near term costs can be covered by grants, direct taxpayer subsidies and indirect support from affiliated utilities. Long term, the goal is to make FTTH systems fully self-sustaining and to do that you need market share, certainly 40%-plus and likely in the 50% or 60% range.

Which means taking subscribers away from incumbent cable and telephone companies, who have shown a willingness to upgrade infrastructure, boost speeds and shave prices when threatened by a metro-sized competitor. The incumbents’ ability to leverage continental-scale capitalizations to fight local battles is tough to beat.

But maybe not impossible. Offering a gig for $65 to $70 is something only an FTTH operator can do. At that price, it’s a no-brainer for high end users. At that speed, it’s tempting for mid-level subscribers who haven’t been persuaded to spend an extra $20 or so a month for a few megabits more.

The marginal cost for operators is probably quite low, at least for now. Home subscribers might occasionally enjoy bursting a gigabit, but average aggregate usage probably won’t rise much at first. Those that definitively cross the grey line between residential and business uses can be managed with common sense terms of service. Revenue losses, from the relatively small number of customers willing to pay steeper rates, should be easily offset by higher total subscriber counts.

The fixed costs of an FTTH system are high. The way to be self-sustaining is to spread the pain thinly over many subscribers rather than thickly over a few. Google, and now Chattanooga and Utopia, are using the capacity those fixed costs provide to buy market share. It’s a page out of the incumbents’ playbook.

There’s no guarantee they will prevail, but when the big money is already spent and results are so far insufficient, the greater risk is to do nothing.