David Rodeback's Blog

Thursday, February 23, 2006

It's Crunch Time for American Fork's Broadband System, Part I

A business plan for AFCNet, American Fork's municipal broadband system, is under construction. The bond money which has mostly funded the system is running out. Here's a look at short- and long-term issues and possibilities.

In last fall's campaigns for city council and mayor, there was a lot of talk about AFCNet, American Fork City's municipal broadband system. Notably, future Mayor Heber Thompson promised to have a business plan produced, then evaluate the system's future in the city on the basis of that plan. A business plan is now in production. It should have happened years ago, but then we had a less businesslike administration. Serious people are working on it now, including some with actual, relevant professional expertise and experience. That's the good news. The bad news is, the plan's development and the range of possibilities both are severely hamstrung by an unnaturally short timetable: The bond money that has been covering the system's losses runs out sometime this spring, according to reports during the campaign and more recently.

The reason the short timetable is a problem is that a lot of the best options for long-term viability won't save the system in the short term. You will see this as I discuss major current and possible revenue streams. Note that I am using numbers I heard during the campaign, from various sources, but there's good reason to suppose that they're in the ballpark, which is close enough for this discussion.

Given that we were told that the system was losing about $1.5 million per year, and that it's bringing in less than $400,000 annually from connected customers, it is reasonable to suppose that the system's current annual operating cost approaches $2 million. Note also that the following assumes that the system is used for Internet connectivity only, not the delivery of other digital entertainment products. With these things in mind, here are the major revenue streams I'm aware of.

Residential Service

If AFCNet roughly doubles its residential market penetration, to about 50 percent of resident households; and if the city keeps growing; and if the City's cut from each month's service at each home stays in the neighborhood of $27 (current) to $30, the City's revenues from residential service could reach $1 million per year in the next two or three years. This doesn't approach the even the current cost of the system, but it would be a major improvement.

As to the quality and cost of the residential service, there is good news and bad news. The good news is, the system is far superior to the residential offerings by Comcast, Qwest, and Earthlink. The bad news is, those other services are adequate for most residential users, so AFCNet can't raise its residential prices much without losing a lot of customers. Users like me who need that higher level of performance will struggle to find it elsewhere even at a considerably higher price, so we'd be mostly out of luck without AFCNet. I could pay more for what I'm getting -- it's worth more -- but I seriously doubt there are enough such users to make a meaningful difference.

So $1,000,000 is probably about as high as revenues from residential service can go in the next few years.

Business Service

At last (rather recent) report, only a few businesses are hooked up to AFCNet -- and I don't mean relatively few. I mean few in the sense that I could count them all on my two hands and have some fingers left over. This is a big, sucking hole in the City's management of its broadband system over the past few years.

At my workplace, we recently shopped around for high-speed Internet service, as an alternative to the T1 (very fast) we've had with Sprint for several years. We pay over $700 per month now; we've found competitors willing to provide a T1 for about $500 per month. We would happily pay $400, perhaps even more, for AFCNet.

Here's what you need to know to evaluate this:

First, we looked at AFCNet as a possible business solution. But with one exception several months ago, my inquiries to AFCNet have received no response. I needed a firm answer as to whether the service is available to my office, but I couldn't get one. I needed to know if we could get a good Service Level Agreement (SLA) -- essentially, a guarantee of service 24/7, with some refunds for downtime which are not much, but which tend to guarantee that the provider takes downtime seriously. I couldn't get an answer or even a return phone call about that.

I needed to know the cost; at least I got that. For us, it would have been about $100 per month -- and this is for service that approximately equals and sometimes exceeds our T1. That price is much too low.

I don't know what the costs would be of upgrading the management and support so that a small business would have the necessary SLA and support -- so that there would be someone to answer the phone, or at least quickly return a phone in case of trouble. For many businesses, Internet connectivity is mission-critical, so these basic needs are non-negotiable.

But there clearly is room for price increases to business customers. The $400 per month I cited is for a small business which hosts one production server and a development server. Small businesses with lesser needs could pay $100 per month, minimum, without having their heads turned too much by the private sector providers. Large businesses could be willing pay much more. But all of this is true, again, only if the service itself is reliable and the system's management and support are adequate.

Suppose that 50 businesses connect at $400 per month, and 100 more connect at $100 per month, and the City's cut is 75 percent. There's $240,000 plus $120,000, times 0.75, or $270,000 annually. It helps, but it's not enough. I'm less confident of the revenues large commercial customers might produce, but there might not be a lot of them, anyway.

If you're counting, we've now theoretically covered roughly $1.27 million in costs, or 63.5% of $2 million. (That percentage is important; see below.)

But remember: At present, the system reaches very few businesses. Extending it to them and winning over users is a long-term project. It should have been done years ago, but it wasn't.

Leasing Unused Fiber

The City has far more fiber optic cable installed than it presently needs, so it makes sense to lease some of the unused capacity (dark fiber, so called) to other entities. One deal, for about $1.5 million, was completed several weeks ago. There's a lot more unused fiber optic cable in the City system, and we've been hearing since late in the campaign that several other customers are seriously interested. For legal reasons, I suspect the City needs to take care that they are principally providing a broadband infrastructure to residences and businesses in the city, and leasing unused fiber just because it's there, instead of looking like a fiber wholesaler which just happens to offer service to homes and businesses because it can.

I cannot evaluate the short- and long-term potential for fiber leasing income; I don't have the necessary information. But if it brings in $1,000,000 per year (above costs), and if the residential and business sides of the system produce as I've described above, that gets us in the neighborhood of $2.4 or $2.5 million annually even without large business contracts. But these deals take time, too.

Impact Fees

Impact fees are fees to developers to defray the City's cost in extending infrastructure (such as water, sewer, roads, and probably police and fire protection) to new development. It seems logical that if the City is committed to having a broadband system in the long run, it should charge impact fees to cover the costs of extending that system to new development. Right now, American Fork doesn't even charge an impact fee for roads, but that's a longer story. Whether a broadband impact fee would pass political muster is uncertain, and, for all I know, there may be legal obstacles as well. In any case, impact fees would have to be used to extend the system to new development, so they wouldn't function as revenues supporting the existing system.

How Much Does Long-Term Potential Matter?

Doubling residential market penetration and extending the system to a lot of businesses are long-term projects. Dark fiber leasing and my theoretical broadband impact fees are not exactly short-term projects, either. If the City insists on the system breaking even or better the moment the bond funds run out, there isn't time to develop these revenue streams before the system hits the wall.

Assuming that my projections are in the ballpark, which is a fairly big assumption, then the system can probably hold its own financially in the long term. If it can, and if City leaders believe the system is a positive asset to the City, then they are faced with the difficult question of how to subsidize it long enough for good marketing and good management to have their effects. The City doesn't have a lot of money lying around, for whatever reasons, so it is a potentially painful question of whether the broadband system is a high enough priority relative to other budget items. It is not clear to me that our elected officials will give it that high a priority, even if they like the system and think it would be good to have in the long run. The short-term budgetary hurdle may be higher than they care to leap.

Maybe Someone from American Fork City Should Talk to Governor Huntsman

Governor Jon Huntsman seems very serious about economic development, and when he thinks high-tech, he seems to think of Utah County. And you might have noticed that the Governor and State Legislature are trying to figure out what to do with a billion-dollar budget surplus. Is anyone asking the State about the possibility of some assistance in getting American Fork's broadband system firmly on its feet? I haven't heard, but that doesn't mean it isn't happening. It might be too late in the legislative session to try to get our legislators to propose something that would help right away, but there may be other possible approaches -- and Senator Valentine and Representatives Dougall and Cox might be able to help even with the executive branch.

To Be Continued

I've written here as if AFCNet needs to be at least revenue-neutral in the long term. In the next post, I make my case why that isn't necessarily so. The keywords are "quality of life," "economic development," and "indirect revenues." Stay tuned.

David Rodeback comments (3/9/2006):

I've had the good fortune lately of speaking with helpful and forthcoming City officials (plural) at length about financial and other aspects of the broadband system. I cannot recount the discussions fully, since parts were appropriately off the record. But here are some interesting tidbits.

• I'm told that the City already has a broadband-related impact fee, which is good.
• I learned the quantity of surplus fiber that was leased in the recent $1.5 million deal; apparently, that leaves a roughly equivalent amount of unused fiber available for leasing, so the potential additional income there is not spectacular -- perhaps roughly the same as the recent deal. Also, half of that $1.5 million will go to defraying the City's cost in providing the fiber to the lessee.
• I learned that the ballpark numbers I was using above were, in fact, in the ballpark, though inevitably imprecise.
• In a sense, the system has already served American Fork very well. It appears that ComCast, EarthLink, and other broadband providers came to American Fork far sooner than they would have, because of the City's system. Also, it has long been clear that their prices are lower than they would otherwise be. They have to compete with a fairly economical, vastly superior Internet product here, unlike, for example, in Highland. So even users of broadband systems other than AFCNet have received benefits from AFCNet.

Councilwoman Heidi Rodeback -- like her husband, a very happy user of AFCNet -- is the assigned "prime mover" for the broadband business plan, and Councilman Dale Gunther is applying his considerable financial expertise to the project, as well.

Overall, the most noteworthy effect of these discussions is that I am much more optimistic about the future of my excellent Internet service than I was a few days or weeks ago.

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