Will small ops get squeezed?
The passage of the Telecom Reform Act has dramatically changed the structure of the communications industry. Suddenly, everybody can get into everyone else's business. The bill's advocates hope the new lack of regulation will allow unfettered competition, which should be good for consumers by driving down prices. Opponents claim little will change under the new law, with the exception that more power will be consolidated into fewer hands.
Regardless, the landscape has already begun to change. If the proposed mergers take place, today's seven Regional Bell Holding Companies (RBOCs) will shrink to five. And at least one top-10 MSO will soon disappear under the US West umbrella.
But how might this affect operators of small cable systems? Will it drive them out of business, or give them an opportunity to shine by being different than the impersonal communications giants?
To find out, we asked three different network providers who operate in smaller areas what they think about the future, competition and their competitive edge. The cast includes: Pete Smith, vice president of engineering at Rifkin & Assoc., a Denver-based MSO that has 340,000 subscribers spread over 80 headends; Bill Bauer, an active member of CableLabs and owner of Windbreak Cable in Gering, Neb., who has 230 subscribers in two rural towns; and Ken Wright, chief technical officer for InterMedia Partners, a six-year-old company with 700,000 subscribers that is beginning to cluster, and grow.
What follows is an edited transcript of their comments.
CED: Describe how you and your company feel about the future as a small operator going toe-to-toe with big telecommunications giants. Is that prospect daunting, or are you looking forward to the challenge?
Smith: I have doubts as to whether in the short term that we'll be going toe-to-toe with the telecommunications giants. We operate generally in smaller markets, and I just don't see (the RBOCs) coming into the smaller markets wanting to make a big splash. They're competing in the big markets like Atlanta, Washington, D.C. and Omaha.
That buys us more time to understand the technologies involved and to watch other people develop their businesses, and to use their good ideas. But do I feel comfortable going up against them? You never like to have competition where you didn't before, but I think by the time it happens, we'll be well-prepared to do it.
Bauer: The Telecommunications Act has not had a big effect on me because we were already headed down the paths we're on. But how do we compete toe-to-toe? That's an easy one: we know our small systems better than the large companies do. With the passage of the Telecom Bill, the bigger companies are going to try to get out of having to provide service to small communities. That puts us in a prime position to take over those responsibilities.
Wright: I think we look forward to the challenge, and I say that for two reasons. First, as we look at all this emerging competition, we need to remember it also means there's a lot of emerging opportunity. We've been in this narrow niche of video entertainment for so long, but there are a lot of new opportunities for us to diversify our revenue streams. As you diversify your business, you make yourself less vulnerable to competition. It's daunting to have big people coming after your business but we're seeing the door open to diversification.
Secondly, there's been a lot of talk about how smaller operations are quicker to respond and quicker to act than big companies, but from my vantage point, it's true. There's a reason why everyone says that. In our company, we literally have a handful of people who are strategists and decision-makers. We can pull those people together all in one place at one time, brainstorm, make a decision and begin to implement it all within a few days' time. I see it happen every day in a company our size.
We're also a little different than other operators our size in that we have little geographic spread. We are clustering aggressively through buying and trading systems to where we're concentrated within a four contiguous-state area in the Southeast. In mid-Tennessee, we will soon have 300,000 subs clustered contiguously.
Smith: Am I confident that I'm 100 percent ready to compete with a huge RBOC on telephony services? No, and I suspect anybody for Time Warner, TCI or anybody else would have to admit they're not comfortable doing that yet. That's why people are taking their time and trying to understand the technology, the marketing needs, customer service needs, personnel needs-all the issues that go with a new business. This is not like adding HBO to your system. It's not an ancillary product that's the same or similar to your other products.
By the time those guys come in and want to compete with me, who knows, maybe I'll already be doing a lot of the things they want to offer. Maybe I'll already be in the data networking or telephony business. I may be ready before they come to town and may already have customers that they'll have to try to take away from me.
CED: What will it take to compete with such mega companies? What special advantages do you have?
Bauer: Our big advantage is that we can do things locally. We're much more tuned into what the local people want and how they want it. I think I have the advantage over any competition. In fact, I'm out looking for more systems to buy. I work with the phone companies on a regular basis, so I know what their limitations are. They have a mindset that is 50 years old and that's based on creating more expenses so they can go to a higher rate base. They know one thing - they do it well, but they only know one thing. That does not exist in the cable industry - we're used to working long hours and doing everything on nothing.
Smith: You have to have reasonable amounts of money, that's for certain. You'll have to hire or train personnel for the business you're planning on being in. If we're talking about telephony, for instance, we would view it as a separate product line. We're going to have to work on billing systems because none of the ones we have are capable of transaction-based billing. We'll have to work on lots of hardware issues related to reliability and powering. We don't anticipate being the ones to solve them. We'll watch other people solve them and pick the elegant solution that best fits our needs.
If I'm competing against a big multimedia company, they have some attributes, but so do we, and they tend to offset. They've got lots of money and research behind them, but they don't have the ability to move as quickly as we do; they don't have the flexibility that we do. Bigger organizations tend to have more rigid rules, while in smaller companies, the people are often more empowered and able to meet the customer's needs. The lack of willingness to bend the rules will drive more people to smaller companies.
Wright: Because cable's pockets aren't deep, we've learned to be more strategic with our resources, whether it's capital, time, staffing or whatever. We tend to be more efficient because we've operated with lean resources vs. someone who has operated with a guaranteed rate of return. It's hard (for competitors) to segue to an efficient, competitive mindset. I personally have seen examples of that kind of thinking from some of the new entrants. I see a lot of dabbling, trialing and experimenting that seems incredibly wasteful of both time and capital.
Smith: I don't think you'll see a lot of competition on price. The business community has learned that's not the way to compete. The cellular industry is a classic example of that. Prices are virtually identical in most markets.
I also don't think in a competitive environment that one person gets killed along the way. It's a battle, but does anyone actually win? One comes up with a great idea and gets more subscribers, and then the next guy steals the idea and gets some subscribers back. So there's an ebb and flow.
CED: Can the industry afford to build the kind of network it will take to compete?
Wright: The short answer is yes. To realize that, you just have to look at all the upgrades that are going on. We are spending the money and rolling out the technology. Because we've had to watch our pennies over the years, we're less likely to overspend on technology. In a competitive environment, you have to be efficient so the rate the market will bear gives you a return on investment, and that's been cable's experience throughout its history. That's an entirely different mindset (for the telcos). I think we have the money, but more importantly, we have the savvy to spend that money so that we get a return on our investment.
Smith: A lot of things will take capital, but hopefully, I'll only have to spend a reasonable amount to get in the business and then just add more as I gain subscribers. So that even in smaller markets I'll be OK. Or maybe if it does take a large capital investment to get in, I can share resources with other operators. There's nothing to say that even a big multimedia company that is operating in a large market adjacent to us wouldn't be willing to sell us switch space, for example. That happens in the telephone business right now. There are a lot of little guys out there who don't have a switch, and they rent space from folks with excess capacity.
You can also do things without deploying all that capital upfront. So, being smart about how you do it, when you do it, where you do it and what you're doing, is probably the most important thing.
Bauer: You can't do it (in the) standard ways. The infrastructure costs are just too high, so you have to find unique, innovative ways. One thing we've been looking at is providing alternate access to route a long distance call from a customer to a carrier. That is an easy business for us to get into because we don't have to change phone numbers or get into billing.
We have the parts and pieces to most of it up and running, but we're not quite there yet. The minimum headend cost for a telephone-over-cable system is $150,000. You can't do that in a small system. I've asked (the equipment manufacturers) if they can make it scalable, and they say no. So it's just not cost-effective at all. Everything we do has to be done differently, but unfortunately, major equipment manufacturers don't look at small systems as an opportunity.
CED: What are the keys to success in an open marketplace?
Wright: Number one has to be a focus on the customer. Consumers are expecting more and more. The focus on the customer is paramount. That means we have to be responsive to customer needs, and we have to anticipate those needs. It also speaks to the quality and reliability of the product. There's been a lot of focus on the quality and reliability of our signals and customer perception, and there's been a lot of effort put forth on that.
There's been a lot of cable, and I think it's important to say that cable has been listening and improving. Try calling other utilities or a government agency and put a stopwatch to the wait time. Then call your cable company. We're aware of what it will take to succeed in a competitive environment, and we're not just sitting back wringing our hands. We're getting there.
There also needs to be a focus on the employees because they are the ones who make it happen. That means we have to give the proper level of training and motivation.
CED: So what's your vision of the future? Do large media conglomerates control the marketplace and everyone else is a small company - much like the telephone industry is now?
Smith: I expect there will be consolidation. Big companies will cluster and control the large markets, but I still think there's a place . . . for smaller operators that have marketing savvy and availability of capital.
Wright: It only makes sense that the cable industry will go much like the telephone industry did-from a lot of independent, standalone operations to a small number of large companies. There will always be small operations in the outlying areas, but the whole move toward consolidation will continue. The whole world is headed that way. Cable will be no exception.
Bauer: I think in the near term there will be several large companies and lots of small ones. I think we're beginning to see the pendulum move in a different direction. These companies are getting bigger and bigger. Soon, they fall just from the weight of the overhead. I hate to use TCI as an example, but it hasn't been able to deliver on much of anything it has announced. It has a corporate structure that is making decisions without any knowledge of what's going on out in the field. There are people today who want to launch Internet access, but because they (TCI) made a big commitment to launch @Home and buy all these modems, they've tied the hands of the people in the field. You'll see the same thing happen with many of the telcos when they go the ISDN and ADSL path. They'll spend tremendous amounts of money to do it in one place, but can't duplicate it elsewhere.
CED: What's the big technological challenge that must be overcome in order to compete?
Smith: Doing it right.
Wright: I think it's the same thing as our strength-the network, our legacy. It has incredible bandwidth, but there is the issue of the return path. A lot of talented minds are focusing on fixing that, and we're doing a lot of the right things but we still have a ways to go. We know what needs to be done, that's the good news, and we're doing it. We are upgrading almost every network we have, and all of them are being done as active two-way plant.
CED: What are you doing to explore new services like telephony and high-speed data? Are you being aggressive in those areas, or are you on the sidelines watching for now?
Bauer: We will launch Internet access in a 100-sub system next week (middle of May). We've been working with Hughes on a delivery system that goes over satellite. So we have a satellite downlink that is a shared 12 Mbps and an upstream VSAT link. That is what we're launching. We come to the headend and go to a full blown proxy server with private IP addressing. And from the headend on, it looks like any cable system, but it's much simpler.
We're looking at total headend costs, with software and modem launch equipment, of $15,000 to $17,000. And the modems are $375 (Bauer will use Zenith's 4 Mbps HomeWorks modems).
In fact, we're spinning off another company that will offer this to other small operators as a turnkey system instead of them having to come up to speed on servers, IP addressing, etc. We'll do all that and provide all the support. The learning curve is so steep right now. I've been at it for four years, and I still don't know what I'm doing.
I've been working closely with (other small system operators, like) Buford Cablevision, who has 150,000 subscribers spread out over 232 headends; TeleMedia, which has 400,000 subs in small systems; and Summit Cable in Washington state.
Big systems won't drive the boat, although they'd like to. They won't get to deploying real services quick enough. Look at how long the Orlando project and ECNet in Phoenix have been operational. ECNet has just 50 customers. What's the holdup?
Smith: We're not standing on the sidelines. We've hired a "new business" person with the charge to help us get in those businesses. Data is well above the telephony business as a priority right now, but there are a lot of areas within the telephone business that can be lucrative and are available for competition without taking on full residential telephony. We're looking into that.
There's also the video networking and basic telecom carriage business. Some of that business might now be in the telco's basket that I could take on and maybe provide an upgrade to their service. There's a wide variety of things that can be done without taking on the whole shooting match.
The data networking business does not have to be data just to the PC. It could also be providing data services for governments, businesses and school districts. In fact, taking on those pieces and doing shared tenant services is a nice, graceful way of getting in the business, learning about it and solving a lot of the problems before you decide to launch bigger services.
Wright: We are not waiting in the wings or holding back. We are installing cable modems for a trial and are talking to a lot of other operators about doing several things. We are also partnered in a competitive access operation in one of our markets and are looking at that in other markets.
CED: So, when do you start to compete?
Bauer: If we can get off our backsides and realize we have the advantage here, we can own the data world lock, stock and barrel. What you're about to see is a groundswell of small operators who are going to move into data. You'll see more data customers brought on by small systems than you ever will by the big MSOs, because they have a complex problem: how do you service 100,000 customers? That's a big headache. Forget about the cable plant, the network is the problem. Whereas a small system with one or two DOS computers running Windows NT can get up and running in a week. It's very simple and it works quite well.
Wright: Bill is absolutely right that there is good opportunity in small systems. It is easier to engineer a small system, but it's also true that for people in rural areas who want access to the Internet or to dial into America Online, it's quite often a long distance call. You (small operators) could be the only one on a local basis to offer access to stuff people are only reading about.
From a traffic engineering perspective, in a large system we address that with node sizes, so it's not like we are without hope. We just have to adjust our fiber networks to make them like a lot of small systems.
Smith: To be a little glib, we'll compete when the time is right, when we feel comfortable and understand the rules of the competition. One of the dangers here is picking on someone and causing more damage than good. Hitler picked on some people and eventually he picked on the wrong folks and got kicked. I think you need to be careful about who you want as your enemies. The fact that you're a smaller cable operator doesn't mean you're not a successful operator or that you're not doing well financially, or that there isn't good long-term promise for you. It just means you're a smaller operator. Don't necessarily believe everything you read: you don't have to be in all these other businesses to survive. I think you pick your targets and do it right when you decide to do something.
We plan to be here for awhile and don't believe you need 5 million subs to survive. We think you can survive at our size, or even substantially smaller than our size, if you do your job right.