In his 2011 State of the Union Address, President Obama set a goal of providing broadband Internet service to 98 percent of Americans within five years, and proposed significant funding to build out broadband infrastructure to the country’s hardest-to-reach communities.
To date, many private providers have extended high-speed Internet service to areas across the country. However, the costs of deploying, upgrading, and operating and maintaining broadband infrastructure mean that some communities remain without access. In addition to the services provided by the private sector, some local governments across the country have developed their own broadband networks, both in areas currently served and “unserved”. Historically, the government has stayed out of the telecommunications business, and most economists agree with this policy. In many rural areas, for example, small private firms have provided such services with the help of federal subsidies, like those offered by the Rural Utilities Service (RUS).
This BNA Insights article provides an overview of the issues concerning municipal broadband projects, examines their failures, and makes public policy recommendations for increasing access to critical broadband services nationwide.
For Our Broadband Future, a Question of Public v. Private.
The United States is a market-based economy, allowing the market to address economic wants and needs in the most efficient and cost-effective manner possible. The market has worked exceptionally well in meeting consumer demands and has allowed private enterprises to supply the market with an abundance of choices.
As Gerald Faulhaber argues, “The private sector is absolutely best at competing with better prices, better service, higher quality, new innovations and exploring customers’ preferences—far better than the government will ever be.”
According to Alfred Kahn, “The central continuing responsibility of legislatures and regulatory commissions [is] finding the best possible mix of inevitably imperfect regulation and inevitably imperfect competition.”
It is important to consider whether a government possesses the expertise to develop and operate a broadband network. This is an important question, especially in industries like broadband where technology is constantly changing and firms need to be flexible and have the ability to constantly update their business plans. Communities that want to invest public funds must have well-defined plans, goals and milestones.
The Problems with Municipal Broadband Projects
The history of municipal broadband networks has been one of various problems: Failure to achieve universal service in areas that they serve; the lack of a viable cost-benefit analysis, which has led to costs outweighing benefits; the inefficient use of scarce resources; the inability of municipal broadband networks to cover their costs, which has led to government failure; the unfair competitive advantages given to a government entity, which has resulted in anticompetitive behavior; the opportunity cost of using limited tax funds on municipal broadband networks and not on more essential services; and the stifling of private-firm innovation. The existence of a municipal broadband network does not assure universal service because there is no guarantee that the network will be built out to reach all residents in a given geographic area. The cost to build the infrastructure to certain areas may be prohibitive because of terrain or density of population.
The financial models built by governments looking to deploy municipal broadband networks fall short in four major areas: (1) The initial investment is generally higher than planned; (2) Penetration rates are systematically overestimated;
(3) Revenues earned are lower than expected due to responses from competitors; and
(4) Operating costs are almost always underestimated.
Municipal broadband networks create inefficiency and cause waste.
Municipal broadband networks use their competitive advantage from the tilted playing field as well as the ability to artificially inflate competitors’ costs to foreclose entry into the market. As technology changes, a private firm may be able to make a business case for entry into high-cost areas. However, where municipal broadband networks operate, such entry is unlikely to occur because of artificial barriers that deter private entry.
For example, in the City of Hawarden v. US West Communications, the city was sued concerning a discriminatory “user fee” of 3 percent that was imposed on non-municipal entities. The ordinance was put into place after Hawarden created a municipal communications utility, but the Iowa Supreme Court found such a practice unconstitutional.
A municipal broadband network that faces financial difficulty has three choices:
(1) Sell at a loss;
(2) Continue using outdated technology; or
(3) Introduce new investment and better technology, which will in turn increase its costs and lead to a bigger deficit with higher prices, higher taxes or a cross subsidy from other products in the case of multiproduct producers.
Raymond Gifford and Mark Walker argue: “Subsidizing municipal communications services leads to higher taxes, jeopardizes bond ratings and increases the cost of other municipal services. It may also have the unrelated consequences of entrenching inferior communications technologies.”
Ashland Fiber Network (AFN) Oregon
AFN was launched in the late 1990s and ultimately accumulated debt of $15.5 million, $9.3 million for construction costs and $6.2 million to cover operating losses and issuance costs.
In January 2005, Ashland City Council voted to give a $1 million subsidy to AFN, of which $540,000 came from the wastewater fund and $460,000 from the electric fund. In October 2005, the city of Ashland adopted a surcharge of $7.50 on all electric bills to subsidize AFN—a surcharge that was later rescinded after protests from citizens. In December 2005, $500,000 was given from the electric department to help AFN pay its debt. Property taxes now help cover part of AFN’s debt.
Originally, about 1,300 households did not receive AFN services because it was too costly to build the infrastructure to service certain areas.10 In this case the network was not willing to provide universal service to the entire geographic area because of the costs of servicing certain areas. Thus, residents who were not offered system access or who chose not to use it were still required to subsidize the network through higher property taxes. In declining to provide service to hard-to-reach areas, AFN engaged in the same business practices as private firms—namely, avoiding high-cost areas. However, unlike a private firm, when the network declines to serve all households in its area, property owners who do not have access must still pay for the system in the form of higher taxes as well as higher electric rates to subsidize AFN.
AFN’s former IT Director Rob Lloyd stated, “As people download movies and do other activities online that gobble up bandwidth, controlling costs is critical.” He also stated that, “People who use excessive bandwidth — up to 20 percent of customers—will likely see higher charges of up to $25 per month.”
MI-Connection North Carolina
In 2007, Davidson and Mooresville, N.C. took over the Adelphia Communications cable company despite an offer from Time Warner. MI-Connection, a municipal network, was born. Troutman, Cornelius, and Huntersville had considered joining with Davidson and Mooresville, but found the idea too risky. A consultant’s report issued before the purchase said the network would be profitable by 2013 and would eventually add to the city’s revenues, contributing funds to other vital programs. Jim Bensman, a Cornelius town commissioner was skeptical, arguing that the consultant had underestimated costs and overestimated revenue.
Bensman was right. Today, MI-Connection has a negative net worth (its debt totals $81 million) and profits are not anywhere in sight. In fact, Davidson and Mooresville are looking for an exit strategy. Since 2010, MI-Connection has received around $14 million in subsidies from Davidson and Mooresville, taking from other priorities to give to MI-Connection. Mooresville’s Town Manager Erskine Smith said the “town likely would tap its unappropriated general fund balance for extra cash.”
Things will get worse in 2013—the very year the system was expected to turn a profit. Mooresville has committed $5.3 million and Davidson, $1.3 million. Davidson’s most recent budget said “until our commitment to MI-Connection is reduced.” the city cannot achieve financial stability.
As a result, some political candidates are calling for an exit strategy. MI-Connection Chairman John Venzon has said he’s trying to make the company as attractive as possible so it can be sold in 2017.
Burlington Telecom Vermont
Like many municipal networks, Burlington Telecom is currently in dire financial straits. It also faces a lawsuit, has illegally borrowed from taxpayers, is past its deadline for completion, and has failed to attract subscribers. Christopher Mitchell stated that “In little more than a year, Burlington Telecom went from being a hopeful star of the community fiber network movement to an albatross around its neck.”
The primary issue is the system’s debt load. A state audit (the Blue Ribbon Committee) found the that the network has been in violation of its state license for the five years it has been operational and that there is no feasible way that it can repay its debts.
The second issue with Burlington Telecom is that $17 million of its $51 million debt was illegally borrowed from taxpayers. When the Vermont legislature approved Burlington Telecom, as the Associated Press noted, the system was required to be a “stand-alone entity” that could not “use taxpayers’ money to support its operation.”
The network’s legal issues do not end there. Unlike other municipal networks, Burlington made a business decision to lease-purchase the network from Citibank. Unfortunately, “In 2010, the city council did not appropriate payments to the lease, resulting in the agreement’s legal termination.”
Like many municipal networks, Burlington Telecom has also had trouble fulfilling its promises. The network has only about 4,000 subscribers, far below the number city administrators had projected. The network cannot afford to spend money on a marketing campaign so it will be difficult to increase subscribership.
The city is now looking for someone to buy the network, but that is also difficult given the lawsuit. The current mayor says that he does not want to spend “additional precious taxpayers dollars gambling on the future of a telecommunications company,”
Outside of a sale (and that is unlikely to recover lost revenues), there seems no solution to Burlington Telecom’s financial troubles. Burlington Telecom has debt of $51 million and revenue of $7 million. The city would need debt service totaling $3 million to refinance $51 million. The Blue Ribbon Committee estimates that it would need revenues to exceed $25 million to cover the $3 million debt service. Thus, even if Burlington Telecom could find financing, it would be spending more than 42 percent of present revenues on debt payment.
At $51 million in debt, Burlington Telecom has failed on its basic promise-to provide universal access to residents of Burlington. There is no money to expand the network there is not even money to market the service to potential subscribers. Burlington Telecom should heed the advice of the Blue Ribbon Committee and sell at least a majority ownership to a private firm, if it can find a willing buyer.
In Feb. 2014 Burlington settled the lawsuit with Citibank and will pay $10.5 million upfront to the bank and 50 percent of the city’s proceeds from the sale of Burlington Telecom. To pay the bank the city received a $6 million “loan” from local businessmen Trey Pecor who will receive a portion of the proceeds of the sale of Burlington Telecom
UTOPIA Utah
In 2002, the 11 cities that eventually joined the Utah Telecommunications Open Infrastructure Agency (UTOPIA) did so by undertaking a $135 million bond. In total, it has $185 million in bonds, of which only 59 percent has been used to build the network. The original plan was that the system would take three years to build and in five years have positive cash flow.
Salt Lake City Mayor Rocky Anderson noted the pitfalls and hazards presented when the city considered joining UTOPIA. He stated, “During the UTOPIA debate, we thoroughly reviewed and analyzed the possibility of joining UTOPIA and concluded this endeavor posed unacceptable risks to taxpayers, particularly in light of emerging technologies.”
An August 2012 audit report to the Utah Legislature
The 2012 audit report chronicles the various reasons for the network’s poor financial performance. It also questions whether UTOPIA’s business model, providing broadband infrastructure at wholesale prices to independent content providers, can be profitable.
UTOPIA’s financial problems go all the way back to June 2006 when it received a $66 million loan from Rural Utilities Service (RUS). UTOPIA was given $21 million to start, but in February 2008 the Rural Utilities Service suspended the rest of the funding “until UTOPIA improved its financial condition and developed a new business plan.” This was a major problem: UTOPIA, believing it was guaranteed the additional RUS funds, had already started construction on new phases of the project. UTOPIA had to suspend work when it did not get additional funds.
UTOPIA’s original business plan was to build everywhere at once instead of completing—and getting service up and running—in one area and then another and so on. This meant that when UTOPIA ran out of money, infrastructure was stranded and unusable. The audit report asserted that a better plan would have been to complete one area at a time so the network could generate revenues quicker. More knowledge about how to build fiber networks would also have come in handy. The audit report “faulted UTOPIA for not charging residents any installation fee or a allotting a minimum subscription period to defer the cost of the last mile installation. As a result, a large number of subscribers left the network without UTOPIA recovering the cost for the last mile installation.”
UTOPIA’s management problems have had real consequences. The network was to be completed in September 2007, serving 141,000 addresses at that point. By that time, only 37,160 addresses had access to UTOPIA. About four-and-a-half years later, in April 2012, only 58,100 had access. In other words, five years after the date the municipal leaders promised the network would be done, only 41 percent of the homes the network promised to serve actually had access to it.
As a result, UTOPIA has never met its subscribership goals. By September 2007, city leaders said that there would be 49,350 subscribers, about 35 percent of the homes with access to the network. In April 2012 there were only 9,340 subscribers—less than a third of the number of subscribers the network anticipated having five years earlier.
Ultimately, the audit said UTOPIA managers put the project in the “hands of less qualified outside contractors who “did not have the expertise to effectively execute that vision.”
As the audit points out, UTOPIA will live on as long as the member cities that are members are willing to raise taxes, a reality some cities are already facing. In Orem, the city council proposed a 50-percent property tax increase, $2.8 million of which would go to UTOPIA. Few Orem citizens even benefit from UTOPIA. Only 38 percent have access to it.
Residents, of course, were not happy and the city compromised by raising taxes only 25 percent ($1.7 million). The rest would be made up by cutting funding for city service vehicles, taking monies from city reserves and foregoing a wage increase for city workers.
The situation in Perry is even more perplexing. Zero taxpayers have access to the system, even though they are on the hook for thousands of dollars in bond payments. UTOPIA has invested $2 million in unfinished infrastructure in Perry; since Perry did not join the Utah Infrastructure Agency, it has no current plan to complete the network in Perry. In 2013, Perry is scheduled to pay over $105,000 to back UTOPIA bonds. That figure will increase two percent a year until 2040 even though it is uncertain whether even one Perry resident will use the network in the intervening 30 years.
UTOPIA still does not have a formal written development plan. Its current net worth is negative $120 million. It cannot cover operating costs let alone contribute to any debt payments, and has not reached its goals of universal access. Also, given that the audit indicates that UTOPIA may never turn a profit, Utah communities will need to make up for any future losses.
Utah taxpayers should not suffer for the inexperience of UTOPIA’s administrators. Salt Lake City mayor Rocky Anderson understood that; it is time lawmakers in UTOPIA communities do too.
Networks Selling at a Loss.
Some examples of networks being sold at a loss is FiberNet, an Internet service provider built by the city of Marietta, Ga. in 1996. Eight years later, the city sold FiberNet for $11.2 million, a fraction of the $35 million that was spent to build and maintain it. At the time of sale, Mayor Bill Dunaway addressed the need to constantly upgrade the system stating, “That’s why we should not be in the business - you have to keep reinvesting … [Its] negative cash flow once you consider reinvestment of capital.”
In 2004, Groton City launched Thames Valley Communications, a municipal network offering Internet, cable, and telephone services. It was a subsidiary of Groton Utilities, which had a history of successfully managing such public utilities as electric and water. However, as it would learn, the telecommunications industry is much different, with consistently changing technology and competition. In total, Groton City borrowed $34.5 million for Thames Valley Communications and in February 2013 the company—which lost money every year—was sold to a private company for $550,000. Groton Utilities is assuming the $27.5 million debt of its subsidiary.
iProvo, in Provo, Utah, was recently sold to Google for $1. The network was built in 2004 at a cost of $39 million financed through a bond issued to the city. The network had financial difficulty from the beginning and was not able to cover its operating costs. In fiscal year, 2007 iProvo lost $2 million and the city allocated $1.2 million to stay in business. In 2008, the city sold the network for $40.6 million. However, in 2011 the company that bought iProvo defaulted on its purchase agreement and iProvo again belonged to the city, along with its $37 million in debt. In November 2011, Provo residents’ power bills reflected a $5.35 a month charge to help pay the bond.
Final Thoughts for Policymakers.
Across the country, local governments are struggling to balance their budgets. Especially in times like these, taxpayers have a right to question how city and county leaders are spending their money. Lawmakers have a responsibility to ensure that limited funds go to such truly critical public services as law enforcement, fire and rescue, education, and infrastructure.
Many cities and municipalities have entered into the broadband market with disastrous results. Governments should not overburden citizens with ventures that result in no benefit and actually harm consumers. Municipal operated networks have fared quite poorly because they have neither the resources nor the expertise necessary to provide consumers with reliable state-of-the-art broadband connections.
Government failure is especially prevalent in markets like telecommunications, which are subject to considerable technological changes in a short period of time. The result has been subsidies to keep them afloat or the sale of the network at a loss.
In a dynamic market such as broadband services, government ownership has proven to be an abject failure. Broadband is a compelling example of a service that governments are ill-suited to provide.
Municipal networks often receive an unfair advantage over private networks because they do not operate under the same tax structures and regulatory rules. This makes private providers reluctant to make investments in an area where the deck is stacked against them, which then results in lower tax revenues. In addition to scaring away potential revenues, municipal networks are inefficient and are often great wastes of taxpayer money. They are often duplicative of private commercial networks and almost always add to taxpayers’ total debt burden.
Unfortunately, efforts by municipalities to build broadband networks have not been the best solution and have failed for several reasons:
- Municipal networks use taxpayer funds and federal grants to build networks in areas where private providers already make high-speed Internet service available. This network “overbuild” is counterintuitive, in that it requires taxpayers to fund and subsidize a network that duplicates an existing network.
- Many networks fail because they lack a sustainable business plan, the long-term resources to invest in maintenance and necessary upgrades as technology evolves. When this has happened, the taxpayers have had to fund the failures.
- Municipal networks compete unfairly with existing providers. As a government entity, a government network can practice various anticompetitive activities which put private firms at a competitive disadvantage. Thus, municipalities that use taxpayer funds to build a broadband network actually act to forestall market entry and decrease competition. With municipal networks, consumers lose the benefits of competition and choice. They also lose tax revenue from a private network that might have otherwise entered that market, and taxpayers pay more in taxes as they subsidize the operation and maintenance of a municipal broadband networks.
Historically, the government has stayed out of telecommunication services provision, and most economists agree with this policy. The government should not be involved with broadband network ownership because markets are functioning properly. In unserved areas, public-private cooperation will lead to better results than municipal networks. Public policymakers should remove barriers to private investment and give firms the proper incentives to enter unserved markets.
Joseph P. Fuhr Jr. is a professor of economics at Widener University. In the field of telecommunications, writes frequently on investment and innovation, rural telephony, terminal equipment, and universal service. He can be reached at jpfuhr@widener.edu.
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