The recent brouhaha about the FiOS customers that Frontier acquired when it bought part of Verizon’s local telecom operations has raised questions about the viability of the FiOS business model. Frontier has said it cannot afford to offer FiOS video service at the rates that Verizon was charging, which may be due in large part, to Frontier’s smaller video customer base and, accordingly, its lack of leverage with content providers. But is that the only problem?
Frontier has planned FiOS video price increases as great as 46%–and although content costs are one of the largest components of a video provider’s cost structure, they’re not the only one, which suggests that, all other things being equal, Frontier’s programming costs would have to be considerably more than 46% higher than Verizon’s in order for Frontier to justify raising prices by such a large amount. And some might argue that it’s unlikely the two carriers would face such a big programming cost disparity, regardless of their respective sizes.
One influential telecom analyst has suggested that there may be more to Frontier’s concerns than just programming costs. According to a recent report from Business Week, Bernstein Research analyst Craig Moffett has suggested that FiOS may not be profitable for Verizon either.
I’m not a financial analyst, so I don’t claim to be able to confirm or dispute what Moffett says—and as Moffett notes, a company the size of Verizon has discretion in how it allocates costs. That makes it difficult, even for an expert, to get a definitive answer.
But one thing has always nagged at me about the impact that today’s multi-play strategies have had on the various types of broadband providers that have embraced them. When cable companies began offering data and voice services, their overall margins climbed dramatically—quite simply because the market rate for those services was a lot more than the cost of service delivery, and a big relief from the comparatively narrow margins the cable companies were accustomed to earning from their traditional video service business.
As telcos shifted their focus from high-margin voice services to data–and, eventually, to video services—the exact opposite was true. And compounding the situation was the fact that the coaxial cable the cable companies already had into the home could inherently support higher bandwidth than the twisted pair wiring that the telcos had deployed, making it easier and less costly for the cable companies to upgrade their networks to support broadband services.
Telcos didn’t have much choice. With traditional voice services eroding and demand for broadband mushrooming, they had to upgrade their networks to support data—and many of them viewed video as a way to maximize the revenues they could generate from their broadband networks, as well as a necessary service component to counteract the cable threat.
From a purely financial perspective, however, the cable execs have tended to look like the smart guys while telco execs have been on the hot seat, having to continually justify the logic of the direction they are taking.
The upshot is that all telcos are facing the kinds of challenges that Verizon and Frontier have seen. But Verizon is taking more heat than some other telcos because in making its broadband platform decisions, the company has erred on the side of spending more now with the goal of being in a better position to meet increasing bandwidth needs in the future—in FIoS markets, at least. Not every Verizon market is getting FIoS, simply because it is a costly platform to deploy.
Depending how quickly bandwidth demand accelerates, Verizon ultimately may look like the smart guy—among the telcos, at least. Cable companies face an easy upgrade path to supporting 100 Mb/s service through an upgrade to DOCSIS 3.0, suggesting Verizon will continue to face stiff competition from at least one lower-cost competitor in FiOS markets for the foreseeable future.
Frontier, meanwhile, may find the FiOS platform it inherited from Verizon to be quite profitable as a means of delivering only voice and data service, but that may not be a true gauge of the platform’s true viability, as the price that Frontier paid Verizon for it may not correspond with what it would have cost to build the same platform.
