Entner: Economics work against government-owned networks

dollar sign money
Due to inherent high fixed cost, the early stages of any network deployment are a hallmark of large losses until the network reaches scale. (Getty Images)
Roger Entner

Telecom networks, whether they are wireless, wireline, or cable, have high fixed costs and low variable costs. This means that it is very expensive to build and maintain the networks to connect customers, but once they are connected, it is not very expensive to serve them.

We are fortunate right now, as we have several new market entrants around the world that we can use as benchmarks to test our hypothesis.

 

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Expanding coverage in the U.S.

In the United States, Dish Network estimates that it will cost $10 billion to provide coverage to 75% of Americans in every one of the company’s 416 license areas, or roughly 90% of the U.S. population. Dish is building a software-defined-network similar to what Rakuten in Japan and Jio in India are building.

During the last four years, Rakuten has built a nationwide network in Japan for $8 billion, with 96% population coverage. The company claims it saved 40% on costs to build its network using SDN compared to what its competitors have spent to build theirs using older network design technologies.

How is this relevant to the U.S.? The United States land mass is 26-times larger than Japan and has 2.5-times the population. Further, American consumers are more widely dispersed over a larger geographic area than the Japanese.

Using Rakuten’s spend as a recent network cost benchmark, building out the U.S. will be at least five times as expensive as building out Japan, or roughly $40 billion to reach around 90% to 95% of Americans. To reach the next 5% to 10% of much harder to reach Americans, it could cost at least $80 billion, even with the cost savings that come from building an Open-RAN network.

Usage support costs

Once the network is built, the cost to support usage is the next consideration. Mobile operators with more than 60 million customers generally report that it costs them around $9 per month to serve a customer, on top of what they spent to build the network.

Operators with around 5 million customers report that it costs them roughly $15 to serve a customer. This does not include marketing costs, device subsidies, network improvement and build-out costs or profits. Wireless operators spend around $30 billion per year to improve and upgrade their networks to next generation technologies like 5G, which is roughly another $10 per month.

Sales, marketing and administrative (SG&A) costs are somewhere between $13 for a large provider like Verizon and $25 for a small provider like US Cellular. It may come as a surprise, but it is not uncommon that mobile operators report in their financials that their device costs are greater than their revenue from devices. This means that even after selling high profit margin accessories, they still lose money on selling phones. This subsidy is often in the $200 neighborhood per new customer.

Competitive disadvantages

The intensity of the competition is evident with the new iPhone 12 launch. AT&T and T-Mobile are providing discounts of up to $850 per phone. That discount is mostly paid by the mobile operator, perhaps with some co-marketing dollars from Apple added, reducing the operator outlay.

It will be difficult for a state-owned operators, regardless if local, state or federal, to match offers like that without significant market distortion and political blowback since essentially tax dollars are used to subsidize devices made by trillion dollar market cap companies. The left will bemoan corporate subsidies and the right will bemoan handouts to citizens in order to hurt private businesses. Economists will just call it “crowding out.”

The cost structure of telecom networks makes it difficult for new network-based entrants to compete against the established providers. It does not matter if the new entrant is a company like Dish Network or a government-funded or sponsored provider like the phantasm that spooks Washington every few months.

Due to inherent high fixed cost, the early stages of any network deployment are a hallmark of large losses until the network reaches scale, limiting the ability of the provider to provide service without having to go into significant debt.

In addition, the provider has to think already about the next generation service, which comes usually every seven years at which point the provider will become more and more uncompetitive if it does not offer the next generation services. We are launching 5G services now, but by 2027 we will probably launch 6G. Anyone launching a 5G network in 2023 has only four years until that next upgrade cycle is going to hit.

Entner chart 1

And all of this is before the need to show a profit for a commercial network provider. It is going to be difficult for any new entrant to be profitable even in the medium run. Even with new software-defined networking features that can lower the cost of providing service what some estimate up to 30%, the cost savings would be in the $3 to $5 range per month per customer. What is a significant saving for a mobile operator in aggregate, it is a relatively minor change in the monthly recurring charge the consumer pays.

A fixed broadband provider has an even higher cost to connect potential customers. There are 4.18 million road miles in the United States, 77% of which are maintained by local authorities. These local roads are used to connect homes and businesses. One mile of fiber costs between $30,000 for easy telephone pole deployment to $200,000 for trenched deployment.

Even if we take the low-end $30,000 per road mile, we have a conservative $96.6 billion price tag to connect everyone living directly on a road. At a more reasonable $50,000 per road mile we are at $161 billion. Interestingly, large broadband operations are more expensive to run than wireless networks. Using the same cost-to-serve a customer calculation we used before, it costs about $20 to serve a broadband customer per month, but SG&A is less at $7 to $8 per month. The cost to upgrade and expand the network is roughly $20 per month per existing customer.

Entner Chart 2

These hard costs put constraints on new entrants, regardless if they are private businesses or government sponsored. To make connectivity more affordable, these costs can only be mitigated through persistent loss making or subsidies from the government.

The future of broadband coverage nationwide

The plans of both parties are to connect more if not all Americans with broadband. It comes down to a build versus extend-and-buy decision as both new entrants and existing entrants face a similar cost structure, with new entrants not enjoying economies of scale savings.

To overlay existing network coverage with a government paid or even built network creates the danger of the government crowding out private businesses as it discourages investment. The government can just raise taxes to better compete with the private businesses already providing service. It is in a much better position to compete and undermines the investment case for the existing providers leading to inferior service for all.

The better solution to achieve the governments coverage and connectivity goals is to incentivize private companies to extend their networks to where they have not yet reached. The costs are lower, the time to connect all Americans is shorter, and the government involvement in private enterprise is less. If the government wants to reduce internet access costs for citizens, the cheaper and more effective ways are subsidized and discounted programs like Lifeline rather than the creation of a new competitor in the marketplace.

Roger Entner is the founder and analyst at Recon Analytics. He received an honorary doctor of science degree from Heriot-Watt University. Recon Analytics specializes in fact-based research and the analysis of disparate data sources to provide unprecedented insights into the world of telecommunications. Follow Roger on Twitter @rogerentner.

"Industry Voices" are opinion columns written by outside contributors—often industry experts or analysts—who are invited to the conversation by Fierce staff. They do not represent the opinions of Fierce.

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