There are opportunities for utilities despite the telecom market correction of 2001 and 2002.
The benefits gained when electric and gas utilities enter the world of commercial telecommunications services are obvious. Telecommunications services allow utilities to leverage many core competencies, assets, and human capital. Additionally, new entrants enjoy some competitive advantage over operators of older networks; just 70 pounds of fiber optic cable can transmit as many messages as one ton of copper wire and with only 5 percent of the energy needed. Market demand is making possible new revenues from video, data, and wireless services, not to mention such bandwidth-intensive applications as Internet access and application services. Yet the risks for utilities entering telecommunications are real and ever present. A thoughtful strategy of building upon established competencies and achieving incremental advances is the soundest path to manage risks and climb the telecom value curve. From elementary right-of-way (ROW) transactions to complex application hosting, the difference between success and failure in the fast-breaking world of telecommunications technology lies in understanding and mastering each progression in a five-stage continuum.
Naturally, just because a pulp mill is good at producing paper, that is no indication it will succeed in the newspaper business. Yes, it can be done, but it would be essential to develop and match core competencies to support more complex tasks. Similarly, many utilities enjoy a sustainable competitive advantage in managing physical assets such as poles, ducts, and right-of-ways, paving their way for entry into telecommunications. However, success in entering telecommunications services comes from working through incremental advances-building as you go.
The transition of moving from a dark fiber optic lease transaction to a lit fiber managed bandwidth service can mean the difference between $100 per strand mile and $800 per strand mile. But as Chip Smith, president of DukeNet Communications Inc. in Charlotte, North Carolina, warns, "At the retail end, selling to the end user, the competition is murderous." Revenues are richer the further along the telecom continuum, but the risks also increase, sometimes exponentially.
The key to success is to establish competence at each stage of the journey and then leverage that proficiency, experience, and credibility to move deliberately up the curve. The communications value curve can be thought of as a five-stage continuum. The basic stages of progress are outlined below:
- Real estate transactions (right-of-way)
- Facilities-based transactions (dark fiber)
- Wholesale services (managed bandwidth)
- Retail services (voice, video, and high-speed data)
- Complex value-added applications and services
ROW Real Estate Transactions
Currently, more than 80 percent of America's largest 100 utilities have entered the telecommunications sector at some level. Virtually all utilities own and operate large and complex private telecom networks in support of their core business. Additionally, utilities have become more telecommunications-dependent for their core business. Mission-critical applications such as sub-station management, energy trading, and demand-side management are dependent upon connectivity. This means a utility's entry into telecommunications is a natural extension of the core business.
Initially, many utilities began their involvement in commercial telecommunications as relatively straightforward ROW transactions. However, the incremental revenues that can be derived from a foot of ROW (a basic asset) grow exponentially as the utility invests capital and takes a more active role in providing service. As an example, a straight facility lease or "landlord arrangement" typically yields revenues of $.25 to $6 per foot, per year, depending upon the market size and demographics the ROW addresses.
Adding fiber optics to the ROW requires an additional capital investment; however, the investment radically changes the inherent value of the ROW asset. The resulting lease value can be increased to an estimated $100 per strand mile per month, again depending upon the addressable market. Using a benchmark standard for comparison, the resulting revenue derived from a foot of ROW can be extended from $.25 to $20 per foot per year by moving one step up the value curve. While there are many assumptions in this estimate, it represents a fair point indicator of the value enhancement.
Moving up the value curve can increase the utility's value extraction exponentially. ( ) But here is the rubor one of them! Too many utilities have been attracted to the allure of these returns and sacrificed significant resources trying to compete with large telecom businesses already in place. Others, however, have succeeded admirably.
Lighting Dark Fiber
The economic incentives to move up this value curve are extremely attractive and compelling. But the problems associated with this optic bonanza can be many and varied. Of the utilities that have failed in telecommunications, and some have failed in spectacular fashion, there are a few common themes. The successful entrants maintained a disciplined and orderly trajectory along the path toward success. The key question is: How can an electric utility prudently manage its entry into telecommunications and leverage its assets so as to maximize value?
In our experience every successful enterprise has four common qualities:
- A clear business strategy and objectives that everyone in the organization understands.
- Specific accountabilities for each person in the organization, with direct linkage between accountabilities and business objectives.
- A good management team with the capability to execute efficiently.
- A business strategy based upon exploiting the enterprise's sustainable competitive advantages.
While the need for these elements seems obvious, in fact, few organizations can put all these pieces in place at once. However, it is the last of these tenets of success-business strategy-that specifically causes the most problems. Reasons include:
- The failure to identify a sustainable competitive advantage.
- Falsely seeing advantages where, in fact, there are none.
- Moving too slowly to establish new competitive space once an advantage has been exhausted. The key to success is to build or improve a basic core competence, essentially managing risks while creating new competitive space.
Perhaps a better view of the telecommunications value curve is seen in the context of the risk-adjusted opportunity. Figure 2 depicts the relative risk and return profiles for two different enterprises in the telecommunications business-an energy utility and an existing telecommunications service provider (TSP). The straight line represents the typical risk-return profile of an existing TSP, and the curve represents the risk-return profile of a utility at various stages of the telecom value curve.
At the lowest end of the risk and return curve-ROW-utilities are decidedly less risky than telecommunications enterprises. Designing, constructing, and managing line extensions, facilities, and rights-of-way are core competencies of the utility industry. In fact, most local exchange carriers and cable TV providers rely on using electric utility infrastructure, typically through joint-use agreements, in deploying their networks.
In this scenario, adding a physical asset-fiber optics-to the utility ROW is essentially an extension of the utility's core competency of managing physical assets. The utility is decidedly less risky than the TSP. Because electric and gas utilities own and control over 80 percent of the ROW, poles, conduits, and ducts in the United States, the utility will enjoy a much higher return than a TSP that must procure easements at market rates.
For those utilities that already manage large private communications networks, it is an extension of this core competence to continue up the value curve by adding optical gear, lighting the fiber, and selling managed bandwidth. Typically, managed bandwidth is sold as a wholesale service to TSPs that provide retail services to the ultimate customer. At this point in the value curve most utilities have achieved their maximum value potential from existing strengths, and prudently managed the business risks. The sustainable competitive advantage at this level of the value curve is about physical access and assets.
From this point forward, there is a point of inflection in the value curve. "Life gets more complicated," says Bruce Hamer, program director for fiber optic enterprises at Los Angeles Department of Water and Power. As retail services are offered, the sustainable competitive advantages shift from physical asset-based to information- and intellectual-based. Dealing with retail customers requires a complex set of operational-support systems, customer-care facilities, and a sophisticated sales and marketing machine. In the area of the curve ranging from ROW to managed bandwidth services, the physical assets can comprise up to 70 percent of the cost of sales. In the retail services and beyond, the physical assets typically comprise only about 30 percent of the cost of sales. Clearly, a utility's advantage is dulled beyond a certain point in the value curve, and the TSP becomes the less-risky and more profitable enterprise.
Complex Applications and Services-Crossing the Point of Inflection
One example of crossing this point of risk inflection was Carolina Power & Light's (now Progress Energy's) venture into telecommunications with its subsidiary, Interpath Communications. Interpath was a successful, but small, wholesale service provider. A new management team was recruited to build Interpath into a more material business. Attempting to establish a first-mover advantage in an emerging market, the new management team took Interpath from the wholesale service space into complex application hosting ().
Irrespective of the fact that the enterprise had distanced itself from any core competence, Interpath was entering a new market space with unproved demand and new frontiers of technology, financial, and market risk. Predictably, the results were unsuccessful and Interpath has since been restructured under a more proficient leadership team, divested of certain elements of the business, and repositioned where it enjoys a competitive advantage.
Utilities hoping to leverage their assets, expand to new markets, and succeed in telecommunications must adhere to working inside the portion of the risk frontier where they possess competitive advantages. This is not to say a utility can never succeed in retail services. However, to do so it is vital for them to succeed first at the lower levels of the value curve and only gradually engage in higher-value services. At each step of the progression, a utility must build upon its experiences, establish credibility in the marketplace, and identify the source of its competitive advantage. Gradually, the risk curve can be shifted to position a utility to be less risky and achieve higher returns ().
One unique structural issue in the telecommunications industry is that the most recent entrants should enjoy a cost advantage since incumbent providers are saddled with less efficient and higher cost networks. This should make it easier for electric utilities to break into the retail service sector. However, as the Interpath example identifies, there is much more to achieving a sustainable competitive advantage and satisfying customers than a cost advantage.
No Boilerplate Solutions
Given the general telecommunications market correction of 2001and 2002, there is much concern and skepticism about the virtue of utilities engaging in telecommunications. There is no question that much long-haul transport capacity is available. However, there is a critical last-mile and local loop capacity shortage, particularly outside the largest ten metropolitan areas. With almost a 3.5 percent slice of the gross domestic product, telecommunications is a fundamental building block of the new economy. The underlying demand for telecommunications services is still growing and there are significantly fewer competitive options to serve that demand.The opportunities are real, and they are growing. There is a significant and valuable role for utilities to play in this vital sector of the marketplace.
There are no boilerplate solutions for electric and gas utilities to succeed in the telecommunications business. The value curve analysis provides a proven framework and methodology to assess each utility's situation. Astute managers will assess every opportunity in the context of the utility's market, demographics, business strategy, and competitive environment. These are core considerations for succeeding in the expanding telecommunications industry.
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