Cable modem mania is beginning to build
Broadband data services have recently received a lot of well-deserved attention from the media and cable system operators. These novel data services provide extremely high-speed and cost-effective access to the Internet and other electronic services to residential and commercial subscribers. They create new value for cable system operators by capitalizing on cable systems' most unique assetĐinstalled coax cable to the home. In addition, broadband data services will create a foundation for the growth of new revenue sources as traditional video entertainment services reach market maturity.
Before investing in a broadband data service, it is essential to explore its deployment and operating costs. Maximizing investor value depends heavily on the functionality and cost-effectiveness of the cable modem system used for service delivery. This cable modem system has the capability to drive up to three-fourths of the investment cost in such a service.
Broadband data services are targeted to cater to the growing consumer and business uses of on-line services, the World Wide Web and other emerging Internet applications. These data services provide content and high-speed transport of networked applications over hybrid fiber/coax (HFC) systems using the Internet Protocol (IP). The broadband data system shown in Figure 1 illustrates the major components of a system that provides high-speed data services over an HFC network. Computers and communications equipment used in this type of service are located in subscriber homes and headend sites (or regional headend sites for operators of multiple headend locations).
- Cable router. Cable routers (or other types of modem termination systems) interface data traffic from the two-way HFC system to locally and remotely attached networking devices. The cable router interfaces data traffic from the HFC system to standard IP networks; manages bandwidth and spectrum usage in the HFC system; provides robust operation in existing noise environments; implements encryption for secure data transport over the shared HFC network; and downloads software to subscriber modems to provide feature upgrades without dispatching technicians.
- Router/switch. A standard router, or high-speed data networking switch, combines local network connections from multiple cable routers with other data networking devices or servers using standard LAN/WAN interfaces.
- Network management system. The cable system operator uses a network management system to monitor operation and change configuration of components. The system automatically detects and alerts the cable operator to malfunctions.
- WWW caching server & Internet firewall. A World Wide Web caching server stores frequently accessed Internet information within the cable system to reduce Internet access requirements and improve subscriber response times. These computer platforms also act as an Internet firewall, providing increased security.
- Local application servers. Local network applications, such as e-mail and WWW servers, can be deployed within a headend environment as part of the cable operator's broadband data services. Subscribers will realize better response times for locally stored content compared to remotely stored Internet content. Local content storage is an additional value-added service for the cable operator.
- Subscriber management system. The subscriber management system is used to control and monitor individual subscriber access to data services. The system also interfaces with an external billing provider, if one is used by the cable operator.
- Cable modem. Cable modems interface the HFC system coax cable to a standard 10BaseT Ethernet in the subscriber home. The 10BaseT Ethernet LAN (a short twisted pair cable from the modem to the PC) is used to connect one or multiple subscriber PCs to the broadband data service.
- Subscriber PC. The subscriber's personal computer is connected, via the local Ethernet, to the high-speed IP data service. The data service enables a high-speed connection to the Internet, on-line services and content offered by the cable operator. Using this service, subscribers can transport data at more than 100 times the speed of existing dial modems. In addition, subscribers always have instant access to the broadband service, eliminating the delay caused by dial-up time and busy signals when using dial modems.
The economic model shown in Table 1 quantifies the value created by such a service and identifies the key levers in maximizing investor value. This model indicates cash requirements for constructing, as well as cash generated from operating, a basic broadband data service in an HFC system passing 50,000 homes.
The cash flow model for broadband data services assumes a stable data service penetration of 20 percent after six years, and is based on recent dramatic growth in on-line service subscriptions and WWW usage. All deployment investments, operating costs and subscriber revenues have been scaled to the number of subscribers in this system.
Revenues in Table 1 are generated by a fixed monthly subscription fee of $25. Subscribers receive high-speed access to the Internet in return for this monthly fee, which is moderately higher than the fees for on-line services. Other potential revenue sources, such as advertising and local content provision, are not included in this model because they are evolutionary services and will vary from one system to another. These additional services are noteworthy because they can generate high margins, leverage the installed broadband data service and represent future growth opportunities. These services may subsidize the monthly service fee, similar to the way advertising fees cover the cost of basic television programming.
Cash expenses for the service listed in Table 1 are divided into four categories. First, there is a "system upgrade cost," which covers the HFC system improvements that might be necessary prior to deployment. It is assumed that all equipment and labor costs for activation of the two-way plant must be incurred. Installation costs for filters that improve ingress noise in the upstream spectrum and replacement of one-half of all data subscriber drops are also included.
The second cash expense is the "HE cost," which includes all equipment costs and installation fees for networking components in the headend. Headend costs include operators' costs for cable routers configured to support increased traffic capacity as penetration grows. WWW caching and application server requirements also scale with penetration. The $200,000 in subscriber management expenses incurred in the first year includes a Simple Network Management Protocol (SNMP) platform and the development of operator specific management applications and billing system interfaces.
Finally, local and wide area network equipment, interfaces and installation expenses are included. The economic model assumes use of the Fiber Distributed Data Interface (FDDI) for all local area network connections in the headend. The local routers, servers and HFC communications equipment (including cable modems) are designed to support full-speed (30 Mbps downstream, 768 Kbps upstream) connectivity for users who are browsing WWW content and downloading audio and video clips. Multiple T-1 private circuits are assumed for Internet connectivity until the third year, when a T-3 private circuit connection can be cost justified. A system integration fee for installation and startup services, in addition to the development of operator-specific management applications, is also included. Integration services are an estimated 20 percent of all headend equipment costs.
A third category of expenses in the model is "subscriber cost," which includes all subscriber equipment and installation. This model assumes that subscribers are responsible for providing local Ethernet connections to personal computers. (This is a low-cost card and installation provided by many computer resellers.) Installation of in-home cable outlets accessible to the subscriber PCs is included in the installation costs. The primary subscriber cost is the cable modem shown in Table 1 as $500 in the first year, with a 20 percent annual price reduction over the seven-year investment horizon. The estimated cable modem pricing is based on estimated manufacturing volumes during the investment horizon.
The fourth expense category is "operating costs." Basic high-speed Internet service costs are estimated in Table 1. The marketing and sales expenses are estimated at 5 percent of annual subscription revenues. This figure assumes incremental expenses to existing sales and marketing costs for the cable operator. Internet access fees assume multiple T-1 private circuits (or, after year-three, a T-3 private circuit) connecting to the Internet and are based on current access charges. Network management costs are for personnel expenses associated with seven-day-a-week, 24-hour coverage. It is important to note that an equal or larger reduction in HFC system management expenses could offset ongoing network management costs. Billing services, comparable to those for existing cable services, include the cost for use of an external billing provider. Finally, customer service expenses are based on the experience of on-line service providers.
Operator cash flows listed in Table 1 are determined from estimated revenues and expenses and discounted at a reasonably conservative 15 percent cost of capital. The net present value per subscriber indicates the value created by making the broadband data service investment commitment, and is $520. The annual cash flow generated by each subscriber is $195 at maturity. This figure is comparable to the annual cash flow per subscriber received from all existing cable TV services (in 1994, Multichannel News estimated the value for all MSOs was from $135 to $230).
A closer look at the costs associated with deployment in Table 1 provides insight into the importance of a cable modem system. Figure 2 illustrates these costs.
Figure 2 indicates that the most significant use of cash (37 percent) over the investment horizon goes to operating expenses. The second most significant use of cash (22 percent) is modem investment. This suggests that a well-designed cable modem system, one which minimizes operating cost and modem investment, is a major lever in the value creation from a service investment. Furthermore, the third most significant expense, system upgrade cost, depends heavily on the noise sensitivity of the cable modem system. As a first year cash outlay, the system upgrade cost is also an important consideration in the selection of a cable modem system.Leverage of the cable modem system
Cable operators should seek to maximize the value of their broadband data service investment by carefully selecting the cable modem system deployed for subscriber services. Features of a cable modem system can drive up to three-quarters of the investment cost in such a service, as suggested in the examples below.
First, consider modem pricing sensitivity. If, in the analysis above, modem prices were to fall by only 10 percent annually, rather than 20 percent, the net present value per subscriber for a data service investment drops by approximately $100, or 20 percent of the $522 shown above. Operators should carefully consider their cable modem system architecture selection to insure that it is one of enduring low cost, which will fall as manufacturing volumes increase.
Second, consider the difference that operational features of the cable modem system, shown in Table 2, make to system operators.
The difference between the best and worst case operating features, identified above, may mean there's a need for one or two additional operating personnel, less productive installation and more complex HFC system management, and modem upgrade processing costs that add up to $210 per subscriber (using the model presented in Table 1). Because this exceeds 40 percent of the net present value created per subscriber, operators should be aware of these critical operating features when selecting a cable modem system.
Finally, consider the system upgrade costs that are incurred prior to service launch. If the robustness of the selected cable modem system could allow operation in noisy cable systems with large node sizes, and if the dynamic signal level range of the cable modem system is wide enough to tolerate HFC plant variations over time, system upgrade costs may be reduced by another $80 per subscriber. The robustness of the cable modem system also has a significant impact on the value created from a data service investment.Conclusion
It is widely known that customers have accepted many of the evolving Internet services. Broadband data service is an exciting new technology that takes advantage of the inherent broadband capabilities of cable TV systems to provide Internet connectivity. With the increasing demand for high-speed data services, cable operators are well-positioned to generate new revenue streams. As mentioned earlier, however, it is essential that operators avoid potential pitfalls and maximize the value created in deploying a data service by selecting a cable modem system designed for maximum throughput, robustness in existing RF environments, low-cost deployments, operational simplicity for service providers, and ease-of-use for subscribers. This type of cable modem system not only capitalizes on today's market requirements, but also establishes a strong foundation for future service growth.