Spinning its Wheels

Policy Study

Spinning its Wheels

An Analysis of Lessons Learned from iProvo's First 18 Months of Municipal Broadband

Executive Summary

fter only two years, the municipal broadband system in Provo, Utah has begun to show the pattern seen in other cities that have mounted expensive fiber optic networking projects. With less than half the subscribers expected by this date, iProvo, the $39.5 million system launched in July 2004, has had to request $1 million in additional funds from the Provo’s electric utility to meet its costs.

The request for additional funding comes after a troubled first eighteen months of operation marked by slow growth and a rocky relationship with a retail partner that came to an abrupt end during a heated mayoral campaign. The sole bright spot is that iProvo construction has stayed on schedule. The iProvo web site reports that all eight construction phases were completed by the initial July 2006 deadline.

iProvo is set up as a city-owned fiber optic network that wholesales capacity to retail service providers. The unit operates under the administration of the Telecommunications Division of Provo City’s Energy Department. Construction on the iProvo network began in July 2004. As of December 1, 2005, fiber optic connections were available to more than half of Provo’s approximately 27,000 residences and 4,100 small businesses, making it the largest municipal broadband system in the United States to date, according to Broadband Business Forecast, an industry newsletter. Local newspaper reports place the subscriber total at 7,700 as of October 2006. iProvo also owns and operates a cable television distribution facility.

iProvo began with high hopes. But for all the optimism that the city had found a better formula in wholesaling, the experience remains a warning to other cities that municipalities, even when they take a wholesale role, cannot compete with the private market. Despite the advantages it had at the outset, just two years into the project, iProvo is dealing with the same struggles other municipalities have had in the past. iProvo is behind on its business plan and being forced to borrow more money. In February 2006, Mayor Billings and iProvo officials have asked the Provo City Council to approve a transfer of $1 million from Provo’s electric utility reserve to cover fiscal 2006 costs. In June, iProvo requested an received a line of credit for an additional $2 million to cover costs in fiscal 2007 and 2008. iProvo officials also said in October that the operation will need 12,000 to 15,000 customers to break even, an increase the original break-even target of 10,000 customers. The original plan had anticipated iProvo achieving 10,000 customers by December 2005. With revenues and customer uptake short of goals, there is mounting pressure on asset value and cash flow. iProvo’s “burn rate” (the rate at which expenditures exceed income) in fiscal year 2005 was $325,000 a week.

iProvo’s wholesale plan attracted only one retail partner, HomeNet Communications, in its first year of operation. That relationship proved a disaster that ended with HomeNet pulling out of the market in July 2005 and declaring bankruptcy. Of the some 2,400 customers HomeNet and iProvo started with, as few as 1,600 were left by the time HomeNet closed up shop. This occurred as Mayor Billings was in the middle of a heated re-election campaign in which iProvo performance was an issue. This put pressure on Billings to find replacements for HomeNet quickly, giving more leverage to would-be partners to extract favorable concessions from the city.

Cable and Internet prices charged by iProvo partners are not significantly lower than pricing from Comcast or Qwest. An original goal of iProvo had been to offer broadband services at “affordable” rates, implying the rates charged by private service providers are too high. Yet, when compared with similar service packages from the incumbent cable and telephone companies, iProvo’s two current retail partners (Veracity Communications and MStar Metro) do not offer sizable discounts.

There is little evidence to suggest iProvo has generated any significant growth in broadband usage or penetration in Provo. All reports suggest that the great majority of iProvo’s 5,000 customers had broadband service prior to iProvo, either as customers of bankrupt Provo Cable or as customers of Veracity and MStar.

iProvo’s current retail partners, Veracity and MStar, are two local Internet service providers (ISPs). They replaced HomeNet in August 2005. While the city of Provo funds construction and maintenance of the fiber optic backbone and cable head-ends, fiber-to-the-premises (FTTP) connections to each home and business are the responsibility of Veracity and MStar, which are principal points of contact for consumers. The two iProvo retailers compete with other broadband and cable TV providers, including Qwest Communications International and Comcast Corp., as well as direct broadcast satellite (DBS) companies and other ISPs. Large users, such as Brigham Young University, do business directly with iProvo. The city of Provo is also a customer of iProvo.

Yet just two years into operation, iProvo has had to call on the city’s power of the purse. In the free market, failing companies close shop, and that is the end of the financial loss. In requesting an allocation from the city’s electricity reserve, iProvo can do what no private company can: crosssubsidize broadband operations from other utility funds. The electricity reserve fund was created as a hedge against price increases in the cost of electricity, a volatile market as it is. Provo’s electricity customers, not its broadband users, pay into it. Although iProvo seeks only $980,000 of the $17 million in the reserve, it establishes a precedent and leaves the electric utility, and its customers, that much more vulnerable.

In addition to engaging in overt cross-subsidization, iProvo demonstrates more subtle problems municipal broadband systems create for taxpayers and the local economy when they attempt to compete with the private sector. For example, when the city of Provo sold Provo Cable’s customers to HomeNet at 40 percent of true market price, it indirectly subsidized HomeNet’s market entry. In selling a key asset for less than what it was worth, Provo cheated both local commercial service providers and Provo taxpayers.

Set up under a wholesale model, iProvo also was touted to be immune from the problems municipalities have had with retail FTTP systems. That has turned out to be a false hope. Indeed, while financial reports looked good in the first year of operation, much of iProvo’s revenues were generated from interest accruing on bond funding that had been banked. Although the warning signs were there, namely in the form of poor customer growth, iProvo officials chose to play them down. It was only in its second year, when cash from the bond issue began to deplete, that iProvo’s revenue shortfalls and cash flow problems came into high relief.

For a project that began as an example of innovative urban planning and pro-active technology policy, iProvo has had an inauspicious 18 months. In its first year, certain aspects of its balance sheet and revenues appeared sound, but they do not stand up on closer examination. Because it calls for a smaller investment, the wholesale model appears more attractive. The wholesale model is getting more consideration as more cities contemplate municipal wireless networks. Yet the cautionary tale of Provo is that operating as a wholesaler is not enough of a hedge against the financial and logistical problems that occur when a city seeks to compete with commercial service providers in a competitive business sector.

This report will look closer at iProvo’s history and performance, both from a financial perspective and in terms of its goals for creating an effective, competitive broadband alternative for the people of Utah and show why its current woes, like so many other municipal systems before it, should come as no surprise.