The Other Side of the Gold Rush

Realities of the Inevitable Land Grab

Once the fiber optic gold rush in rural and suburban regions peaks, Economics 101 will take over. Over the next several years, we’re likely to see consolidation among rural and suburban fixed broadband operators that will create a relative handful of national and superregional operators in the US.

Government subsidies have fueled the growth of these operators, but the long-term economics will not support profitability for such a highly fragmented collection of companies.

For operators, growth comes from pricing power and the ability to add subscribers; with multiple players vying for the same customers, competitive pricing is unlikely to support significant expansion. At the same time, the slow rate of population growth and low rate of household formations combined are likely to reduce the number of potential customers. This leads to a market where the upside is limited beyond the point of market saturation. Consequently, scale will matter. Annual growth rates for fixed broadband operators have averaged about 3.6% for nearly a decade, spiking during the pandemic to about 4.5% and then moving back to around 3.5%.

Now, we’re entering a period of perhaps the largest rural infrastructure investment since the Rural Electrification Act (REA) was passed in 1936 and provided federal loans for the installation of electrical distribution systems in isolated rural areas of the US for 58 years. While there isn’t a singular broadband act to match the REA, massive public and private investments are being made, such as the $65 billion BEAD funding from the 2021 Infrastructure Investment and Jobs Act.

This focus and the accompanying subsidies to deliver broadband to unserved and underserved Americans are creating a gold rush for hundreds of operators ranging from municipal broadband authorities to hybrid cable companies. But what will the world look like on the other side of the gold rush?

Fool’s Gold or Revenue Growth? 

The growth model for fixed broadband operators is simple: average revenue per user (ARPU) times the number of subscribers equals revenue. The question of ARPU growth comes when a market reaches saturation. Can an operator look to ARPU as a continued source of revenue growth? At the same time, video revenue-generating units (RGUs) are on the decline as people decide against paying for linear TV services. ARPU represents the total price paid by the customer and RGUs are the individual offerings that add up to that figure.

Bundling helped cable providers grow by offering data, voice, and video together. But increasingly customers are choosing to buy only data services because they already have mobile phones and can stream video on their devices and TVs.

Additionally, we’re seeing aggressive pricing for data plans by new market entrants and defensive incumbents, which is also keeping pressure on ARPU. Thus, revenue growth must come primarily from new subscribers.

To transform costs, operators need to improve the economics of upgrades, overbuilds, and greenfield deployments. Inflation, supply chain, labor, and geography are pushing costs higher, which in turn requires an operator to achieve higher penetration rates.

The impact of the 2021 Infrastructure Investment and Jobs Act, the CARES Act (COVID-19 relief), and the Rural Development Opportunity Fund, coupled with state programs, will significantly increase the build-out and total number of planned homes passed to unprecedented numbers.

Household formations (HHFs) measure the number of new households formed annually and are an indicator of subscriber growth. However, both American population growth and HHFs are at their lowest points in decades. Another measure of subscriber growth comes from people moving, so we should include move-in and move-out as part of our HHFs. Population growth, HHFs, and moves are likely to remain low during the current period of sustained elevated inflation. Consequently, there are a finite number of homes to pass. For operators, this means protecting and/or capturing subscriber share in their markets.

Reaching the Underserved = Boom or Bust

Operators need to reach unserved or underserved customers, which is where subsidies and private investments come into play. The central reason these customers are in such a position is largely because the economics to deliver broadband haven’t worked in the past. The roughly $65 billion in BEAD government funding has altered that math.

But while it may now be economically feasible to reach those markets, increasing economic returns over time will require new HHFs, an increase in ARPU, and terminal penetration rates of around 40%.

Given what we know about HHFs and ARPU, penetration rates are key to success. The cost to pass homes with the population density of the targeted customers is about $50,000 per mile, plus the amount to connect individual homes. Inflation, labor shortages, and supply chain challenges are likely to push that number even higher over the next two years. The average cost to pass a home can range from around $600 to $1,500 per home depending on density. The net present value (NPV) and breakeven of the cost to pass are directly related to the terminal penetration rate. For their models to work, most operators assume a 40-50% penetration rate. As the cost to pass increases, achieving a higher penetration rate is crucial to obtaining the target NPV for the investment. The higher the cost to build, the higher the required penetration rate. The difference in NPV between a 50% and a 30% penetration rate may well be the difference between a positive NPV and a loss.

Another challenge in achieving terminal penetration rates is the role that fixed wireless access (FWA) will play in siphoning off fixed broadband customers in these markets. Some regional fixed broadband operators have considered a dual fiber/FWA play that would use FWA to deliver broadband to customers where the economics for fiber don’t work. That strategy is being tested as state and local governments seem willing to either subsidize or even create their own fiber broadband authorities to reach many of those same customers.

Types of Miners

Over the next several years, we’re likely to see three types of fixed broadband operators:

1. Smallish “stranded” operators will mostly include the rural municipal broadband authorities in small markets that are not geographically adjacent (in terms of cost to connect) to larger markets.
2. Large incumbent cable operators offer broadband and wireless services. They have a growth advantage in that they’re successfully increasing their ARPU (and consequently revenue) through the bundling of wireless services with broadband offerings. These large cable operators will add broadband customers by upgrading their cable plant and selectively entering new markets.
3. National or superregional rural/suburban operators will grow over the next 3-5 years through a continued focus on build-outs, acquisitions of failed or underperforming regional operators, and mergers with other regional operators. These operators will achieve the necessary operating scale and have a large enough customer base to deliver attractive economic returns and provide additional growth bundling services, such as wireless and other services.

Today, these operators need to prepare for the coming consolidation by focusing on best practices in costs, customers, scale, services, and partnerships to maximize long-term stakeholder returns. To transform costs, operators need to improve the economics of upgrades, overbuilds, and greenfield deployments. Inflation, supply chain, labor, and geography are pushing costs higher, which in turn requires an operator to achieve higher penetration rates.

Competitive pressures will challenge assumptions of 40-50% penetration rates and in turn put pressure on achieving positive NPV for the investments. The cost to acquire and serve subscribers is also increasing, putting pressure on net margins. Operators need to rethink their cost structure by applying a target cost mindset and then aligning operations to the target.

Going back to our simple revenue model of ARPU times subscribers, and the need to achieve a 40% penetration rate, acquiring and retaining customers takes more than just a rate card and good customer satisfaction scores. Investing in customers requires operators to elevate marketing, customer insights, and customer service to a leading position. 

Customers expect a truly seamless experience tailored to their specific needs, wants, and desires. Success requires understanding customer archetypes (for example, gamers, surfers, streamers, workers) and then presenting hyper-personalized offers to each. Marketing needs to tailor propositions aligned to each of them. Operations need to understand where these groups live and adjust deployment plans to maximize subscriber uptake and create influencers within each market. Customer service needs to deliver an exceptional experience in a segment that has notoriously had low customer satisfaction.

Because merger and acquisition (M&A) activity is inevitable for the hundreds of regional operators, it’s important to prepare for scale as operators acquire or become acquired. In both cases, understanding the actions necessary to maximize the probability of a successful transaction is essential. This involves having the right enterprise architecture, operating model, IT platforms, and culture. Operators that are prepared for M&As will be able to move more quickly and realize higher synergies; operational agility matters in this market.