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Annual Privatization Report 2013

ANALYSIS: Despite Glossy Reports, Muni Broadband is Still a Net Money Loser

Subsection of Annual Privatization Report 2013: Local Government Privatization

Steven Titch
May 6, 2013

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ANALYSIS: Despite Glossy Reports, Muni Broadband is Still a Net Money Loser

After several years outside the spotlight, legislative battles over municipal broadband are re-emerging. Goosed by federal stimulus funds, a number of municipal broadband networks around the country were able to meet short-term construction and service goals, even as they face long-term financial questions. In addition, the shift in policy attitudes toward more interventionist government programs, typified in books like Captive Audience: The Telecom Industry and Monopoly Power in the New Gilded Age by former Obama White House Telecommunications Advisor Susan Crawford, has a number of municipalities considering the launch of competitive phone, cable TV and high-speed broadband ventures.

In response, several states, mindful of the checkered financial history of such efforts, and fearing the fiscal liability they pose, have been drafting legislation to rein in these projects which, when they fail, leave taxpayers holding a multimillion dollar bill.

In a municipal broadband project, cities, counties or townships generally issue taxpayer-backed bonds to cover the cost of the network buildout. The idea has been around since the 1990s. Born out of promise to deliver cheaper phone, cable and Internet service, the great majority of these systems have failed, or at best, limp feebly along, mainly because of business plans that overestimated demand and underestimated costs. A 2007 report from the Pacific Research Institute found that all together, municipal broadband and wireless projects lost a combined $840 million between 1984 and 2004. Because state governments are ultimate guarantors of bonds issued by municipal subdivisions, the overwhelming record of poor performance of municipal broadband networks over the past two decades has led 19 legislatures to impose rigorous conditions on cities that wish to build them, if not prohibit them outright. South Carolina became the latest in July 2012.

While proponents point to apparent benefits such as lower prices or retained businesses, even their reports skirt the fact that most of these operations are losing money and face a dire financial reckoning a few years down the road.

The South Carolina bill may have been spurred by reports that municipal overbuilds in Orangeburg and Oconee counties required $27 million in funding from the American Recovery and Reinvestment Act (above and beyond their municipal bonds) to complete their buildouts.

Losses Mount

In the meantime, concerns over the mounting debt of Chattanooga, Tennessee’s municipal broadband system led Fitch, the rating agency, to downgrade the city’s bond rating. The result is that the city now faces higher interest rates for all its borrowing, a cost that will be passed on to taxpayers.

In Utah, one of the most touted public broadband projects, Utah Technology Open Infrastructure Agency (UTOPIA), continues to struggle. Muni broadband proponents placed the blame for UTOPIA’s initial poor performance on bad management. Yet, although a new management team has been in place for four years, UTOPIA has not turned it around. In 2008, UTOPIA’s net operating revenue was negative $6.9 million. By 2010, that figure had grown to negative $9.5 million. Of a possible 56,000 households UTOPIA reaches, only 8,500 have signed up for services, according to the Utah Taxpayers Association (UTA). Today, UTOPIA is $201.5 million in debt. The National Taxpayers Union calculated that if the state of Utah were to be forced to sell UTOPIA, it would owe creditors around $120 million—a burden that would be passed onto taxpayers.

Elsewhere, research by UTA found Ashland, Oregon’s muni telecom system has produced negative net operating revenues every year from 2008 to 2011. Since 2007, Lafayette Utilities System (LUS), the muni broadband system in Lafayette, Louisiana, has seen its negative net assets balloon from $1.6 million to $28.8 million. In the same period, its net operating revenue deficit has grown $100,000 to $16.5 million. An independent audit in early 2012 calculated the Lafayette system was costing local taxpayers on average $45,000 a day.

Finally, in June the city of Seattle reversed plans to reignite a dormant muni broadband plan dating from earlier in the decade. Seattle Mayor Mike McGinn, an initial supporter, backed off after examining the financial problems encountered by the Click Network, a municipal broadband network in neighboring Tacoma. Launched in 1998, Click is still nowhere near paying off its $100 million cost. The lastest estimates, reported by SeattleMet, an alternative publication in the Emerald City, is that the Click Network will run $5 million in the red for the two-year period of 2011 and 2012, despite serving 18,000 subscribers and most city buildings.

The media at large frames the muni broadband controversy as a lobbying battle between monolithic cable and telephone companies and scrappy, underserved towns. While it is true incumbent service providers aggressively fight muni projects, history nonetheless shows municipal broadband is a bad investment, largely prone to failure, and, in the best case, a costly method for delivering local economic benefits that could be realized at much less taxpayer risk.

So while cities such as Chattanooga can credit muni broadband with attracting the occasional new business, they cannot quantify whether the economic infusion these enterprises brought equaled or surpassed the millions invested in the system and the millions in debt that remain to be paid off. And for all the glitzy anecdotes, such as the 1 gigabit per second fiber optic link that allowed Grammy Award winner T-Bone Burnett to play a live duet from Hollywood alongside Chuck Mead, of the band BR549, who was onstage in Chattanooga, financial losses continue to be a persistent problem.

Not a Conventional Utility

Most muni systems fail to earn back their investment. Those that do, fail to meet the initial goals of ubiquity, lower prices and better service. Careful reading of studies that present muni broadband in its most favorable light, such as an April 2012 report jointly published by the Benton Foundation and the Institute for Local Self-Reliance, shows that muni broadband operations regularly underestimate the cost of providing service, acquiring cable TV programming and keeping pace with technology. Lafayette, for example, has run into all three obstacles. In the first case, the utility learned that the wiring in many homes needed to be upgraded to accommodate the last-mile bandwidth speeds its fiber system was delivering, which raised the cost of service deployment. Second, like its private sector competitors, LUS has been facing substantial year-to-year increases in the cost of providing popular cable channels such as ESPN and AMC. Finally, even though initial build out is completed, LUS faces the cost of remaining competitive with commercial competitors. It has had to keep up with new cable modem standards such as DOCSIS 3.0, and with the growing number of high-definition channels and on-demand viewing options. According to sources in Lafayette, LUS delivers only 60 HD channels while its competitors, Cox Cable, DirecTV and Dish Network, deliver 100 or more. Cox also offers services like HBO Go, which allows customers to access HBO programming on smartphones and tablets. LUS does not.

Broadband service providers are part of a rapidly evolving supply chain for content, applications and services, whereby they must deal with retail Internet service providers, equipment suppliers and program distributors, not to mention advertising and marketing agencies. The nature of broadband service requires service providers to devote significant attention to changing technology, consumer devices and content delivery platforms. This makes the broadband business far different from water and electricity utilities—a difference municipalities fail to appreciate.

The supply chain inexperience of Tacoma’s Click Network, for example, was responsible for a big blunder. After lining up three ISPs to handle retail sales of its muni service, and selling them large blocks of wholesale bandwidth to resale Tacoma consumers, the Click Network decided enter the retail business itself. Competing with your own retailers is a mistake learned in Marketing 101; you don’t undercut your own sales channel. Tacoma’s decision to do so was all the worse because it hurt the local small businesses that it had hoped to nurture with its network, while angering and alienating marketplace allies and all but killed a major source of revenues for its operation.

The process has chastened Click Network officials. When it comes to municipal networks, Diane Lachel, government and community relations manager for the Click Network, told SeattleMet, “I say this all the time, and I said it the last time I met with [Seattle] Mayor McGinn. The utility would not make the same decision today.”

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