Wednesday, August 25, 2010

What is a justifiable cost to government and to the end user of a Next Generation fibre network?

As noted in my previous post, the underlying justification for a Next Generation Network is neither a phone call nor a TV service. While the value proposition for each of these functions is more compelling under a NGN, the old networks get the job done.

The true justification for Next Generation Networks is the unlimited evolution of new digital services. These services will deliver improved outcomes in critical social areas such as health care, education, “smart” energy management, and environmental performance. These services will also deliver economic productivity improvements and a plethora of services targeted at individual personal performance and entertainment.

If there was no legacy network, it would be obvious that a fibre grid integrated with mobility wireless would be necessary to underpin even the most basic economic development. This is apparent to developing economies, which are bypassing the copper to the premise approach.

Legacy copper simply cannot compete either in cost or performance. The cost justification challenge for economies that already have legacy networks is: do the “incremental” benefits justify the costs?

There is typically a lot of “noise” from incumbents on the cost equation. This is understandable when you consider it is in the incumbent’s commercial interest to add the cost of the fibre grid to the cost of the copper grid that they already own. If this cost-plus model was accepted, then the end user would effectively be paying for two networks while using only one.

This is, of course, a good gig for the incumbent if they can get it.

Most incumbents argue that their legacy copper network is not a monopoly, or alternatively that network access prices should not be set by regulators based on depreciated costs. These arguments have tended to work in the past because their original monopoly was on phone calls and the regulations they worked within applied to phone call rates, and it is hard to transition these regulations into “network access” regulations.

The end result is that typically, incumbents make too much money from their legacy copper networks and therefore go to great lengths to avoid transitioning from the old copper network to a Next Generation Fibre to the Premise network.

In my view the primary cost focus should be on cost to the end user because ultimately it is about end user adoption. The objective should be to replace the copper with the fibre / wireless NGN while delivering the end user more value at the same price. 

In most markets this can be achieved if the fibre network achieves high penetration; it is worth noting that legacy copper networks needed the same high penetration when they were implemented under a monopoly structure many years ago.

It is quite pivotal to understand that, at high penetration, often fibre can replace legacy copper without increasing the price to the end user. This would be the case in New Zealand and Australia, for example. The challenge is not the cost of the fibre but rather the risk of not achieving high penetration in the near term if the fibre faces competition from legacy copper. With the right regulatory and industry structure (a topic for another day) end users will get more value for the same money because next generation electronics are actually less costly, more flexible and higher performing than legacy electronics.

Progressive governments, pursuing the critical collective benefits that arise from NGNs, typically provide some form of financial support for the private sector. Experts in the private sector use this financial support to offset the near term market adoption risk that arises from competition with the legacy copper network.

In France and Singapore, the financial support that the private sector competes for takes the form of grant funding, amounting to 30 to 40 percent of the underlying costs of the network.

The New Zealand rural initiative (RBI) is appropriately based on a competitive tender for grant funding because of the low market density and significant distances involved. The New Zealand urban initiative (UFB) is not a grant, but rather it is based on a government equity investment in partnership with the private sector.

Under this model, the government investment is purchased by the private sector as customers choose to use the fibre-based services. With high penetration, this approach works for New Zealand’s urban areas because of the increased market density and shorter fibre build distances.

So if end users can get more value and choice without having to pay more and the government can justify the financial support given the compelling outcomes, what is the problem? Why is this so complicated and often controversial?

In my experience, the material complications arise from the commercial interests of private sector participants whose profits rely on the legacy network and the legacy network industry structure.

The only way end users can get more value for money on a sustainable basis depends on the implementation of the Next Generation fibre / wireless technologies. Equally important is the transformation of the industry into two segments: an appropriately regulated transport / connectivity sector; and a “Web Services” sector that is based on open and free competition.

In this transformed industry vertically integrated legacy industry players are faced with many new and, for them, confronting concepts: open access, net neutrality, no competing with your customer, structural separation, and operational separation. These are just a few of the industry structure issues that arise because government bodies and end users have concluded that the legacy industry structure is not performing in the country’s best interest.

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