Beware of Tech Geeks Bearing Gifts

Former FTC deputy director of policy planning says governments

Los Angeles (December 5, 2006) — With hundreds of local governments considering getting into the broadband business, a new report warns that cities shouldn't fool themselves into believing that their experience running water, gas and electricity systems has prepared them for the fast moving Internet world.

The Reason Foundation study written by Jerry Ellig, former deputy director and acting director of the Federal Trade Commission's Office of Policy Planning, outlines seven key factors that municipal officials should fully address before moving forward with plans for municipal broadband and Wi-Fi to ensure that the projects are technologically and financially viable.

The study also cautions city officials to beware of "geeks bearing gifts," suggesting that companies like EarthLink and Google are interested in providing free Wi-Fi because the deals will give them rights-of-way and valuable access to public infrastructure like light and telephone poles.

"Proposals for free or privately subsidized Wi-Fi are obviously attractive at face value," said Jerry Ellig, the report's author and a senior research fellow at the Mercatus Center at George Mason University. "Exclusive access to rights-of-way and poles would bestow a significant competitive advantage on any firm selected to use them. Local governments should beware of granting one Wi-Fi provider exclusive access to public assets, even if the Wi-Fi service itself is free of charge to users. Local governments should not let the sizzle of free Wi-Fi obscure the consumer's stake in competition."

The Reason Foundation report details seven critical issues for governments to tackle before jumping into the broadband market:

  1. Competition: At the end of 2005, 67 percent of U.S. zip codes already had at least four high-speed Internet providers; 93 percent had two or more high-speed competitors; and just 1 percent had no competitors. Thus, municipal cable and Internet offerings face stiff competition and are unlikely to grab a large market share unless they are willing to lose a lot of taxpayer money doing so.
  2. Performance Competition: New government systems will have to offer higher speeds or lower prices to compete with private companies. Existing government systems will need to consistently upgrade their speeds or drop their prices to compete with private sector improvements.
  3. Continuous Improvements: The real consumer price index for Internet services has fallen by 23 percent since the Bureau of Labor Statistics started tracking it in 1997. Unlike traditional government-owned utilities, the lightning pace at which broadband technology improves and prices fall is difficult for municipalities to match.
  4. Technological Change and "Lock-in": The market can get locked in to an inferior technology if government decides to subsidize the inferior technology, thus blocking out better or less expensive technologies. For example, ISDN was short-lived method for sending data over phone lines. Today we don't know how Evolution Data Optimized (EV-DO) technology and cell phone companies will change the market; if we'll see broadband over power lines; or what fiber optic service by cable or phone companies will mean to consumers and the Internet.
  5. Obsolescence: Because wireless technology improves so rapidly, capital investment quickly becomes obsolete. Plans for government broadband need to assume faster depreciation rates than have been used for traditional government utilities. A workable plan for municipal Wi-Fi needs to cover operating costs and recover initial capital outlay in three to five years.
  6. Risk: Broadband is a risky endeavor and governments must not finance it as though it is a low-risk infrastructure investment.
  7. Uncertainty: Since taxpayers bear the financial uncertainty in their role as the owners of government broadband, officials should ensure the accountability and transparency in these projects is at least as good as that of publicly held companies.

"Each government-provided or privately subsidized broadband plan has its own unique characteristics," Ellig said. "But no plan should be considered responsible until these issues have been addressed. Government faces the daunting challenge of entering a market where technological change is swift, the future is uncertain, and competitors' actions are unpredictable´┐Ża playing field fundamentally different from the stable, predictable utility markets that have traditionally attracted public investment."

"As the study shows, the telecom world moves a lot faster than the water or gas systems that many governments are used to owning," said Adrian Moore, Ph.D., vice president of research at Reason Foundation and the study's project director. "With long asset lives and slow technological changes, traditional utility infrastructure costs are not difficult to recover through rates. That is not the case here. If officials get into the broadband business, they are entering a field where millions of taxpayer dollars can be wasted in no time and the technology they bought today is obsolete tomorrow."

To illustrate that point, Reason Foundation has also released a new case study on iProvo, the municipal broadband system in Provo, Utah, that lost $1.36 million in 2003, $1.42 million in 2004, and $1.67 million in 2005. Reason finds iProvo owes more money than it is worth. Overall, assets grew by $2.2 million in 2005, but liabilities grew by $3.9 million. The report finds this gap "shows every sign of increasing and will slowly eat away at iProvo's value and prevent the city from ever getting out from under the debt." And after originally forecasting it would take 10,000 subscribers to break even, iProvo now says it will need 12,000 to 15,000 subscribers just to break even. There are currently 7,700 subscribers, well below the number predicted.

Full Reports Online

The full study, A Dynamic Perspective on Government Broadband Initiatives, is available online at www.reason.org/ps349.pdf. A summary of the study is available at www.reason.org/ps349polsum.pdf.

Reason's detailed analysis of iProvo's municipal broadband efforts can be found online at www.reason.org/ps353.pdf. Reason's municipal broadband research and commentary is here: www.reason.org/telecom/index.shtml.

About Reason

Reason Foundation is a nonprofit think tank dedicated to advancing free minds and free markets. Reason produces respected public policy research on a variety of issues and publishes the critically acclaimed monthly magazine, Reason. For more information, please visit www.reason.org.

Contacts

Jerry Ellig, Senior Research Fellow, Mercatus Center, (703) 993-4925
Steven Titch, Telecom Policy Analyst, Reason Foundation, (281) 571-4322
Adrian Moore, Vice President of Research, Reason Foundation, (661) 477-3107
Chris Mitchell, Director of Media Relations, Reason Foundation, (310) 367-6109




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