Do Broadband Networks Have to be Profitable?

Do network operators have to earn a profit on their networks?  That seems a simple question, but if we consider that operators have reported a decade of decline in profit per bit consumed, we also have to consider whether at some point they’ll be unwilling or unable to continue to expand network reach and capacity.  What happens then?  Australia faced this issue, and their solution was NBN, the “National Broadband Network”, the product of a government-owned corporation (NBN Corp.), and the largest infrastructure project in Australia’s history.

But NBN is considered by many (well, perhaps by most) to have failed in its goals, even after it’s redefined many of them to make them easier to achieve.  See THIS article by Light Reading as an example.  NBN raises a number of questions, three of which I’ll consider here.

The first question is why did Australia take this particular path to providing quality, ubiquitous, broadband, when other countries seem to have done fine without creating what’s almost a return to the concept of a carrier as part of the government?  Question number two is why didn’t the NBN approach work as it was supposed to?  Finally, for number three, is there a realistic alternative to a government-supported broadband future?  We’ll take these one at a time.

Broadband profitability is determined by the relationship between the price of service to the user, and the cost of providing that service.  For virtually all network services, the costliest piece is the “access network”, the part that connects customers to the network and through which their service traffic passes.  Access infrastructure costs per customer are directly dependent on how dense the customer base is.  About 15 years ago, I developed a complex metric called “demand density” to measure this.

Demand density is a combination of the GDP per unit area of service geography, and the density of the right-of-way available to distribute services.  To simplify the measurements, I normalized the formula I’d developed to a value where the US was equal to 1.0.  Countries whose demand density was significantly higher than that of the US would have less trouble creating profitable broadband, and those whose density was significantly less would have more trouble.  On that scale, Australia’s demand density is 0.19, while that of Japan and Korea (both cited as examples of good broadband service) is 12.8 and 9.52, respectively.

Low demand density means you have to string a lot of access to cover your population, which means that your return on infrastructure is low.  Australia’s is the lowest of the industrialized world, which is why they ended up with the problem, and why they sought a form of government ownership and subsidization as the solution.

But as the Light Reading piece suggests, the approach hasn’t worked, and NBN is probably at least as unprofitable as Australia’s national carrier (Telstra) would have been, had it been retained.  What happened?

The most fundamental truth is that changing ownership doesn’t change economic law.  A given level of broadband support will demand a given level of access deployment.  Regardless of who sees the bottom line on their ledger, the way it’s derived from revenue and cost remains.  Government support would have to be financial support, and as the article suggests, nobody is anxious to go to the taxpayer well to draw more dollars.  In fact, it’s my view that the base cost assumptions for NBN were always way too optimistic, made so to get support for the concept.

There’s another fundamental truth, though, and that is that it’s rare that a government corporation is going to create an optimally efficient solution.  Competition among commercial entities is more likely to do that, and NBN effectively killed that.  In fact, the political dimension of NBN made it more difficult for NBN to adapt to new technology approaches than Telstra and smaller competitors would have been.

The third fundamental truth is that it’s hard to hit a moving target, particularly one that’s moving away.  What would be considered “good” broadband today is at least twice as fast as what was considered good when NBN was launched.  The explosion in streaming video has magnified the traffic load by at least a factor of three, perhaps as much as five.  We have more devices per connection, too.  All this adds up to a moving of the goalposts in a game NBN was already losing—was in fact destined to lose.

Which raises the final question; is there another way, another approach?  That turns out to be the hardest question of all to answer.  There’s good and bad news for it.

The good news is that we have some technology changes in play today that NBN didn’t have when it came along.  We also have a financial change, at least a change in financial thinking.  We now realize that broadband in a low-demand-density world has to somehow extend traffic aggregation principles outward closer to the service consumer, and those technology changes offer us options.

The worst of all possible broadband worlds is “home-run” connections between consumers and their serving offices.  One customer has to pay for that access network connection, which means that in low-demand-density areas, costs will be prohibitive.  Things like remote concentrators in copper-loop technology (DSLAMs) came along to provide some local concentration of traffic to eliminate parallel, expensive, links.  We now have fiber-to-the-node or to the curb, with things like 5G as a tail connection to customers.  The cable industry’s CATV coaxial cable has always offered good access concentration, and successive versions of cable standards (DOCSIS) have enhanced CATV carriage of broadband.

But will this solve the problem?  US experience says that it won’t solve it universally.  The US has to provide rural subsidies for broadband services because those demand density issues that bite countries like Australia will also bite regions/states.  In fact, the inevitability of differences in broadband quality by geography, created by differences in demand density, can probably be eradicated only by some form of subsidization.  How much will depend on demand density.

My models say that where demand densities are less than about 3.0, there will be network service geographies that will require some subsidization.  When densities fall to below 2.0, the number of such areas will likely increase significantly, to the point where some government intervention to secure quality services will be needed.  In contrast, where demand densities are about 5.0, there are not likely to be many places where subsidies are required, and operators with a fairly large geographic scope will simply normalize services within their entire geography.

The same modeling says that rather than creating NBN Corporations of their own, other countries should adopt some form of incentive payments to support low-density areas, and should encourage consolidation of operators to raise the footprint of their major players.  The smaller the service area, the harder it will be to normalize services across it without subsidies.  That’s particularly true if the reason the service area is small is that some giant telco sold off unprofitable lines to a smaller company, who then expects to profit from government subsidies.

I’ve not mentioned two other options here—lower costs via virtualization and lifecycle automation and raise revenues through higher-layer services.  I’ve blogged on both these points before, and in any event, it seems clear that most operators are going very slowly on either of these choices.  I also think that while operators can benefit from lifecycle automation, it really only lowers the demand-density thresholds for profitable operation a bit, and in the long run it won’t arrest the declines in profit per bit.  On the revenue side, the sky’s the limit, but operators seem to fear heights.  They may eventually have to learn to face their fears.