DSL Resale Ready to Hit One Out of the Park

Posted: 3/2003

DSL Resale Ready to Hit One Out of the Park

By Tara Seals

2002 was like spring training for DSL after a long, cold off-season. The teams got warmed up and likely contenders began to emerge. This year, the access technology could hit a homer with end users, especially because the Big League brand names have stepped into the on-deck circle. AT&T Corp., America Online Inc. (AOL) and Earthlink Inc. are getting into the DSL resale game in a big way this year -- and smaller resellers will have to fight for a spot in the pennant races.

The outlook of the preseason lineup improves as demand continues to grow. The technology is improving and the applications are becoming more compelling, especially in the business market.

The DSL Forum reports the North American growth rate for DSL was around 11 percent as of fall 2002 -- a healthy uptake rate for rocky economic times. One player, DLEC New Edge Networks Inc., says it is on a rapidly increasing run rate that's almost $80 million a year, from customers in the 360 cities and towns where it provides service.

CONSUMERS: THE WORLD SERIES OF BROADBAND

One match-up to keep an eye on plays out in the consumer segment. The hefty market share of the Bells plus competition from cable operators has made the consumer market extremely competitive, while pricing pressure drives down already-slim margins for resellers.

TeleChoice Inc. found the incumbents account for 89 percent of the DSL market, while the competitive providers make up the remaining 11 percent, led by Covad Communications Co.

"The margins have been getting slimmer, and the reasons are that the RBOCs charge a given amount to us, and the prices have come down in the last year or two, and that makes for slimmer margins for resellers," says New Edge Networks' CEO Dan Moffat. "When you're talking about consumer broadband from the RBOC for $35, up against a $40 cable modem retail offering, that's not much of a business."

Fred Pieplow, COO for regional ISP Quantum Connections, says the only way to make that model work is volume.

"Volume. That's how we do it," he says. "We're also always looking to offer new items our customers will appreciate."

He adds that Quantum Connections, which offers service in Indiana and Michigan, reduces churn and attracts a steady stream of customers by focusing on customer service and offering value-added Web services, such as security and content filtering. The company also provides business accounts.

"Cable operators are really going to focus on the neighborhoods, and they're really going to offer Internet, and then VoIP so you can get your local phone service, and that scares the heck out of the RBOCs, because they regard that consumer business as their bread and butter, and they're out pushing their DSL on the neighborhoods," says Moffat.

All that attention on the consumer market leaves the business accounts ripe for the plucking. One of the biggest mistakes that DSL resellers and ISPs make, says Moffat, is to focus on converting their installed base of dial-up consumers. "Up against the cable guys and the RBOCs is not a good place to be, so it really does require [regional ISPs] to reinvent their business a bit," says Moffat. "They need to get more savvy about business customers. People that are able to reinvent their business are going to be around, and those that aren't won't be around."

Covad, for one, is not concerned with the threat from the cablecos. "[Cable has] still got many challenges -- the shared service aspect where as more of your neighbors get it your speed goes down, and when you really want to surf the Web," says Charlie Hoffman, Covad's CEO. "And the potential security concerns. And of course the cable companies all have huge amounts of debt as well. It's going to be tough for them to make the investments necessary. So sure, it adds competition in the consumer space, but that's OK."

Cable and DSL are neck-and-neck for VSBs
Source: The Yankee Group 2003

ENTER THE RINGERS

One of the reasons Covad's not too worried about the cable guys is it's lineup of reseller ringers, such as No. 3 ISP Earthlink. And when AOL announced last September it had signed with Covad to offer high-speed Internet access, a nation turned its lonely eyes to the giant ISP to bring them low-cost DSL. Sprint Corp., AT&T (which extended its Covad deal in January) and others also signed resale deals with various providers, including the RBOCs, to provide nationwide DSL to businesses and consumers. Many hope the heavy hitters will reinvigorate a market segment wracked by a flurry of bankruptcies.

The DSL market's past instability claimed the lives of NorthPoint Communications, Rhythms and DirecTV's DSL business, among others. The problem was uptake, says Matt Davis, director of broadband access technologies at the Yankee Group. "[DLECS] were going into a market and putting a DSLAM in a central office, which can serve 50,000 potential subscribers, and they think they'll be able to reach about 75 percent of those because of DSL limitations -- that's the addressable market," he says. "And of that 75 percent I might get say 30 percent take rate -- and you're splitting it with another national provider or a regional provider and then the ILEC itself. [So,] the 30 percent, 8,000 or 10,000 people, is suddenly whittled down to 1,500 or so, and that was even a dream. These guys were lighting up six or seven customers out of a DSLAM, and when you're paying for a DS3 for the backhaul, there's just no way they could make that business model work."

Consolidation has turned the market around, helped by the big reseller operators getting into the game and driving more sales. "It's a more beneficial market this year to try and drive penetration into your DSLAM and to actually get enough customers to support the enterprise," says Davis.

The large communications companies have good content at the ready and economics of scale, making the consumer market a good target for them, despite existing RBOC penetration.

"The nice thing about the AOLs of the world getting into this is that they see their job as creating compelling content," says Hoffman. "Meanwhile we worry about the back-end stuff, getting the line provisioned and so on. And they can effectively go after the dial-up base. We're still at 50 million people on dial-up."

But Davis cautions that providers like AT&T and Sprint should be wary in abandoning a facilities-based strategy. "There's a danger if you're an AT&T or a Sprint that is building a lot of services off of a network you don't own," Davis explains. "Even if it doesn't go bankrupt, they may, with a retail strategy, start competing against you, and you leave yourself in a position where you don't have a lot of control over your cost. If you want to raise wholesale prices, either you lose your customer or you accept it...you're in a position where you have other people making your network decisions."

U.S. Broadband Penetration
Source: Point Topic, November 2002

PEANUTS AND CRACKERJACKS

In the business market, resellers can find better opportunities and higher margins. New trends in applications also provide value-added opportunities for business partners.

"We do think the prices for business broadband are as low as they're going to go, and they're going to go up," says Moffat. "If you're getting it from New Edge, for $40 or $45, and you sell it for $80 or more, the average revenue per user for a business user is more along the lines of $130. That's where you can make some money."

The smaller resellers will have a hard time up against competition from Sprint and AT&T, however. "Except the ones that have their niche, a particular thing they're good at and can build a name for," says Hoffman.

One example is Speakeasy Inc., which targets small businesses and consumers, but has a particular additional focus on the gaming industry. Another is, MegaPath Networks Inc., an aggregator known for its nationwide footprint, a rarity in the DSL space.

"One of the redeeming qualities that we have is that we don't just resell, but rather we interconnect with all the major ILECs, Covad and New Edge," says Dan Foster, the company's chief marketing officer. "Our footprint on DSL today is right around 4,300 unique central offices, compared with Covad's 1,750."

That nationwide service offering has attracted distributed enterprises to MegaPath, like Radio Shack, Farmers Insurance, Northwestern Mutual and Honda.

So while the RBOCs and cable operators and the big brand operators battle it out, smaller DSL resellers and aggregators can still grab a piece of the pie. ISPs and aggregators buy wholesale transport, then layer their own differentiating facilities and offers on top.

"They target SMBs, government and sometimes regional and enterprise accounts," says Moffat.

DSL is finding more and more traction in the small and medium business (SMB) market, which includes print shops, graphics shops, insurance companies, dentists, doctors' offices, schools and companies like New Edge Networks' smallest customer, Stan's Astronomy Shop, which uses the high-speed access to transmit star maps.

Application trends and opportunities continue to grow. Local and long-distance phone service using VoDSL technology could be an important trend to watch in the coming months as most providers are taking a look at the opportunity.

"We have an Alcatel [Ltd.] network, carrier class and heavy iron, and we've tested extensively for VoIP and VoDSL," says Moffat. "Some of our 350 ISP partners are already doing voice over our network. We're set up for latency so we can handle voice, so we think longer-term that the opportunity to layer voice over our network is going to be important to us, and later on we'll look at whether we want to bundle that."

The top market for BellSouth Corp. ISPs is home or small office service, says Eric Fogle, director of broadband access marketing at BellSouth, but the call for wide area networking on the rise.

"One of the emerging opportunities for DSL is that now this technology is starting to evolve, one of the things is that reliability and service quality is improving," says Fogle. "We've got a lot of smaller network service providers that are building out wide area networks for corporations and enterprise customers that have branch locations, and they're using DSL as their underlying transport to make that happen. It's a great play, and it's really the emerging opportunity in the transport business to play into that higher margin space."

From a reseller's perspective, it's also an opportunity to provide professional services associated with building out an IP network. "They could also come in and configure the routers, the PCs, do the physical wiring of the Ethernet, all the other ancillary support services that business needs," says Fogle. "The lead to that is, 'I can provide you the DSL service, as well as a complete service offering that includes the DSL.' That's great for the smaller players."

New productivity applications, such as a claims adjuster application, require always-on, higher-level data transmission, says Foster, making DSL a must-have for many small businesses.

"Similarly, some of the pharmaceutical companies are deploying portals out to doctors' offices to augment or enhance the drug representative selling model, so we're helping their distribution model," he adds.

In all, applications, technology and economic health are making for an exciting season for DSL resale. "DSL resale will absolutely continue to grow," says Fogle. "These past two years have been tough from a telecom market perspective, yet in that same time frame I grew three-fold the number of people that are buying the transport services for the purpose of selling to their end users. So in an area where many companies are going out of business, it's also an area where people are going to enter the business."