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 THE STAT 26Percentage of wireless customers who use their cell phones to take picturesMore Vitals
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SEPTEMBER 17, 2002 SPECIAL REPORT: WHAT PRICE BROADBAND? Behind the High-Speed Slowdown Sign-up rates for broadband service are stalling. Is it a tech or a content problem? Neither. It's a pricing problem
In a microcosm, McGrady is what's holding back the broadband industry -- the cable-TV outfits and phone companies that sell access to the Internet at speeds of roughly half that of a typical corporate T-1 line. Over the past five years, some 9 million subscribers have signed up for cable modems, and an additional 4 million are using DSL (digital subscriber line) access that telecoms sell. Yet now, the industry is at a crossroads. Just as broadband signups are about to reach critical mass, their growth is starting to slow -- to perhaps 4 million new customers in 2002, vs. 5 million each in 2001 and 2000, according to ARS, a technology research company in La Jolla, Calif. NONSTOP INCREASES. In large part, it's a contrived slowdown, in which the providers of fast Net access have tested the elasticity of demand by raising prices until consumers balk. In this year's second quarter, the cost of high-speed links finally leveled off after 15 months of nonstop increases. As of June, the average price for cable-modem service was $45.31 per month, up 15% from $39.40 a year ago. DSL service from local phone companies rang in at $51.36 a month, up 7% from $47.84 a year ago. The price differential helps explain why cable companies held 62% of the broadband market as of June, vs. 35% for DSL and 3% for nascent satellite and wireless services. (Another factor is that cable-modem connections are available across more of the country.) Clearly, broadband operators could sign up more customers if they wanted to cut prices. But for now cable companies are happier with higher operating margins -- 35% to 45% on their modem services -- than with scads of new customers. On the other hand, phone companies that provide DSL are having a hard time making it profitable, so they're not as aggressively pushing the service.
CHICKEN OR EGG? While the cable kings are maximizing profitability, politicians and struggling telecom companies are in a tizzy over what they see as a technology tragedy: A nation not sufficiently hooked on broadband. "For high-tech industries and the American economy, bringing on the broadband boom can spark the next sustained surge of economic growth," intoned Senator Joseph Lieberman (D-Conn.) on May 28 before introducing the "National Broadband Strategy Act of 2002," which would require the Bush Administration to come up with a plan to increase high-speed usage within six months of the bill's passage. The theory behind Lieberman's thinking and that of others who support such initiatives is that wider use of broadband would fuel the next stage of Internet innovation: delivering real-time video, music, and other services yet to be imagined directly to American homes and businesses. All told, some 30 bills that aim to speed broadband deployment -- usually, by subsidizing rural rollout -- have been introduced in the House and Senate this year alone. In most cases, those proposals suffer from the misconception that broadband has been crippled by a chicken-and-egg dilemma. Customers have stopped flocking to fast access, the thinking goes, because of a dearth of must-have, bandwidth-intensive applications, such as downloadable movies and easy-to-use music-subscription services. And the reason such services don't exist, according to this theory, is that too few customers have signed up for broadband for big media companies to warrant the heavy investment that such programming requires. SIMPLE SELLS. What's missing from this theory is a little analysis. Historically, communication has been far more prized than content. Annual movie-ticket sales in the U.S. are well under $10 billion, notes Andrew Odlyzko, director of the Digital Technology Center at the University of Minnesota and author of a 2001 paper "Content Is Not King." Phone companies collect that amount every two weeks. Nor has content been the key draw in the Digital Age. AOL users spend most of their time using e-mail and chat rather than the packages of entertainment, news, and shopping information that AOL offers. Cell-phone users have enthusiastically embraced short text messages but have rebuffed wireless application protocol (WAP) "content services," such as weather and news updates and stock quotes. "Simple connectivity and communication services attract much more spending than 'glamorous' content," says Odlyzko.
WARY FOLLOWERS. That in turn has spurred the introduction of new services such as those Washington pols envision, not the least of them online video games. Korea now has more than 26,000 PC baangs, or Internet game rooms, where young people gather to compete in multiplayer shoot-'em-ups, check e-mail, or find a hot date. "The Korean case shows there's a point where content becomes a driver. But the leap from dial-up to broadband depends on other things -- namely price and the ability to keep your e-mail address," says Jed Kolko, an analyst at Forrester Research in Boston. Broadband providers in the U.S. are wary of following the Korean model for a variety of reasons. Cable operators would rather not mess with success. And phone companies fear that even if they did attract more customers, it might hurt the bottom line. Since one phone line can handle both voice and DSL service, a customer who switches to broadband might cut off a second residential phone line that had been used previously for an Internet connection. Though customers pay more for DSL than for regular lines, DSL technology is far more expensive to install and maintain. Plus, its gross margins are slimmer. Still, realizing that they need to be prepared to stimulate demand, cable and DSL providers are slowly beginning to experiment with multiple pricing schemes: The slower the speed, the lower the price. On Aug. 21, SBC Communications (SBC ) announced that it would offer six tiers of DSL service to help draw in more subscribers. Atlanta-based Cox (COX ) is pilot-testing a slower-speed service in Las Vegas for $34.95 a month. For nearly two years, Denver-based Charter Communications (CHTR ) has offered tiered pricing that starts as low as $29.99 per month. VANISHING MARGINS. The trick will be to offer such wrinkles while preserving margins. Researcher Yankee Group estimates that the average monthly operating cost per cable-modem customer, which includes billing, maintenance, data-transport fees, and network management, totals $15 to $23. At $45 per month, cable operators' operating margins are 35% to 45%. If the price of an always-on connection dropped to $25 or $30 a month, those margins would essentially evaporate. "It costs us the same amount to provide a high-speed or a low-speed" broadband connection, says one cable executive who requests anonymity. "When we look at the capital, maintenance, and network-management costs, a person who pays $25 and a person who pays $45 don't look very different. We need to do what's right for the business." That's why broadband operators worry that customers who currently pay $45 per month might downgrade to lower-priced, lower-profit tiers.
BUILD YOUR OWN? Ultimately, broadband providers may have no choice but to lower prices -- because of competition. Already, a company called Wide Open West in Castle Rock, Colo., offers broadband for as little as $19.95 a month -- less than the cost of the AOL service over dial-up -- in select areas in Illinois, Indiana, Michigan, and Ohio. Municipalities throughout the U.S. are also building their own fiber networks. One is Bristol, Va., a town of 18,000 on the Tennessee border, which has built a $3 million fiber-optic network to provide high-speed Internet access to local residents. The small population means users get rocket-fire speeds up to four times as fast as traditional broadband hookups. Don't expect the interlopers to make much headway soon, however. So far, incumbents such as Verizon (VZ ) have succeeded in persuading 10 state governments to limit the freedom of municipalities to provide telecom services, including broadband -- or prohibit them from doing so altogether. In fact, Bristol was able to proceed only because it won a court victory overturning the state law that banned local telecom services. And the Virgina state government is appealing the decision. MASTERFUL DEAL. Instead, new growth will likely come from marketing agreements that broadband providers are beginning to strike with traditional Internet service providers, such as America Online and Earthlink. In August, Comcast cut a masterful deal with AOL, under which AOL is said to pay AT&T Comcast $35 per month per broadband subscriber, along with a cut of advertising, e-commerce, and other revenue. Comcast's pending merger with AT&T Broadband will make it the country's leading broadband operator, giving it more leverage to negotiate than most. But if other cable and DSL providers can extract similar terms, such deals could lure millions of new customers to broadband by making it easier for them to switch -- and, most important, to keep their beloved e-mail addresses. "It's a brilliant deal," says one senior cable executive. "It will spur other deals forward -- and that will expand the market." For now though, in the broadband world, price is king. And as long as that's true, the growth of broadband won't accelerate to warp speed.  By Jane Black in New York Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | SEPTEMBER |
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