Internet & Technology
Monday, May 7, 2001
Investor's Business Daily
The list of casualties in the digital subscriber line firm shakeout seems to grow every day.
NorthPoint Communications is being picked apart in a bankruptcy court. Rhythms NetConnections Inc. is said to be teetering on the brink of insolvency.
And Covad Communications Corp.’s bondholders have told the firm to cool off its cash burn. The DSL provider recently got a notice it will be delisted from the Nasdaq stock market.
Don’t be surprised this is happening, analysts say. Regulations put undue burdens on many DSL companies, which sell a form of high-speed Internet access. Many were forced to compete with the same firms they used as suppliers.
"It was a faulty business model," said Michael Goldman, an analyst at Yankee Group, a Boston research firm. "When you’re competing with the person who is selling you the service, you are at a competitive disadvantage."
DSL converts traditional copper-wire phone lines into high-speed broadband lines. Under the competitive DSL rules, local phone companies are forced to share their copper lines so that Net firms can sell access to their fiber-optic networks.
It was supposed to be simple. DSL firms lease the phone companies’ copper lines, then resell access over those lines to home or business customers.
Regulators hoped this would curb the monopoly advantage of regional phone companies. But the strategy backfired, analysts say.
Line access rates often are too high for DSL firms to make any money.
The rates are based on a complex formula set by the Federal Communications Commission in the Telecommunications Act of 1996. They can be as high as $15 a month.
On top of that, DSL firms pay for space to install their gear at local phone company switching stations.
The typical residential DSL monthly charge is $40 to $50. That leaves little margin to cover operating costs, let alone recoup the costly investment in fiber networks, Goldman says.
DSL firms can’t charge more if they want to compete against broadband service offered by cable TV firms, he adds.
Can’t Compete
That puts regional phone companies at a huge advantage in offering their own DSL access, Goldman says.
"By definition, your competitor is going to be more profitable than you are," Goldman said. "The margin that they’re charging you is profit for them."
This wasn’t a problem at first. Initially, local phone companies stayed out of the DSL market so they could focus on their own high-speed Net services like ISDN and T1 lines, Goldman says.
But after they saw DSL and cable broadband taking some of their market share, phone companies stepped in. That spelled doom for independent DSL firms, he adds.
Phone companies already had access to the tens of millions of homes hooked to their copper-wire lines.
Even if independent DSL firms could pay a nominal fee to use those lines, each had to install its own gear in neighborhood switching stations. And there are tens of thousands of those across the nation.
"It’s easy for economists and lawyers to say open access is easy," said Dennis Carlton, president of Lexecon Inc., a Chicago economic consulting firm. "My experience is that nothing is that simple. It’s much more difficult in practice."
DSL is far more regulated than cable broadband, Carlton notes. That also puts the industry at a disadvantage.
Like phone companies, cable companies have access to tens of millions of homes that are already wired. But they don’t have to hand off their data traffic to another firm, as phone companies do.
Under the Telecommunications Act, phone companies are barred from offering long-distance service to customers within their regional monopolies.
One can’t distinguish between voice and data on digital networks, so phone companies offering DSL have to pass their long-distance traffic through other firms’ networks.
"Disparate regulation can create some very peculiar distortions," Carlton said.
Help From Washington?
A bill in Congress reintroduced April 24 by Rep. Billy Tauzin, R-La., would end that mandate.
His plan also frees phone companies from having to sell their competitors access to their lines at FCC-controlled rates. Lifting that requirement would effectively end the forced open-access DSL business model, analysts say.
Tauzin, chairman of the House Commerce Committee, and its top Democrat, Michigan Rep. John Dingell, hope this deregulation will boost broadband investment by phone companies and encourage DSL rollout in rural, less densely populated areas.
"Why spend the money to roll out broadband when your competitors can use your own network to take your customers?" Tauzin said.
Covad Chairman Charles McMinn told a congressional committee his firm will "have no choice but to withdraw from the residential market" if the bill passes and his line-lease rates rise.
Yankee Group’s Goodman says with or without the Tauzin-Dingell bill, a shakeout among DSL firms is inevitable. But at least a handful of stronger DSL resellers should remain, he adds.
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