Wednesday, January 2, 2008 - The Progress & Freedom Foundation Blog

Broadband UTOPIA?

I've been trying to keep tabs on the status of various municipal wi-fi experiments going on across the nation by posting local news reports about them whenever I see them. The results so far have not been encouraging, but this hasn't been that surprising since those of us who study these issues know that most wireline muni experiments failed too.

And speaking of failed wireline experiments, it appears there's another one that might soon be added to the list. The Utah Telecommunications Open Infrastructure Agency--or "UTOPIA" as it is known--was created in 2002 by local Utah officials who wanted to bring high-speed Internet access to their communities. Eleven communities pledged roughly $200 million over 20 years to back the bonds needed to finance the construction of advanced fiber-optic facilities. Utilimately, the goal was to ensure inexpensive broadband for the masses at minimal cost to taxpayers.

But there are problems in paradise. According to this recent article by Steve Oberbeck of The Salt Lake Tribune:

[F]our years after 11 Utah cities... pledged to financially back the UTOPIA system, its finances are in shambles. Construction is behind schedule. Its top promoters have quit, and its newest chairman has uttered the unthinkable - that despite promises to the contrary, the cities that pledged their support eventually may have to pony up hundreds of millions in taxpayer dollars to prop up the system.

What went wrong?

Part of the problem--as has been the case with most of the failed muni wi-fi experiments--is that the supporters of the plan appear to have over-estimated demand. As I pointed out in a previous essay about muni wi-fi failures, demand counts when it comes to broadband diffusion. Yet, almost all municipalization plans seem to be premised on a "if-you-build-it-they-will-come" theory of economics. But take rates rarely meet the lofty projections of (excuse the pun) utopian central planners. As Oberbeck points out in his article about Utah's UTOPIA plan:

UTOPIA's promoters and the politicians who bought into the dream promised a much different outcome. The feasibility study they circulated in 2003 to generate support for the project indicated that the massive, municipally owned fiber-optic system would be a surefire success. Customers would flock to buy the ultra-high-speed Internet and the television and phone services offered over the fiber-optic network.

To date, UTOPIA's projections have proved much easier to achieve on paper than in reality. UTOPIA promoters estimated that by now - three years into the network's construction - the system would have 22,000 customers and be generating annual revenue upward of $5 million. Moreover, the feasibility study was projecting a "take rate" of 43 percent, which meant that 43 percent of the homes that had a connection available to them would be buying at least one service from the network.

UTOPIA's finances tell a different story. The system has 6,493 customers and has generated $1.75 million, or about one-third of projections. Also, UTOPIA is reporting that its take rate is 16.4 percent, well below the projected percentage needed to break even.

Here we have a wonderful example of the unintended consequences and costs of government regulation and subsidization, and the hubris of central planners could come back to haunt Utah taxpayers. It's one thing for private companies to be forced to eat the expense of over-estimating demand, it's quite another when taxpayers might be on the line for the mistake.

Of course, UTOPIA might recover and still find a way make ends meet. But it will be an uphill fight because private sector broadband providers aren't likely going to roll over an play dead in the meantime. This is the other thing central planners often fail to appreciate; it can be tough for even heavily subsidized government services to compete against private sector offerings, which are typically more responsive to market developments and demands. Some critics (such as many of those commenting on the Salt Lake Tribune website about Oberbeck's article) argue that the private sector offerings aren't good enough, and that's why something like UTOPIA is necessary. But other point out that the government-subsidized service has been mediocre and the private offerings are improving. If that's the case, it will be very difficult for a government-subsidized product to ever capture enough market share to recoup costs and avoid additional subsidized or a full-blown bailout. Oberbeck's article cites economist William Fitzsimmons on this point:

To William Fitzsimmons, an economist with 20 years experience analyzing the telecommunications industry, UTOPIA's success always was a long shot. "For UTOPIA to succeed, you have to assume it is going to capture all of the high-revenue customers and that Comcast, Qwest and other competitors are just going to roll over. That is not going to happen."

Fitzsimmons, who was brought to Utah in 2004 by Qwest to analyze UTOPIA's feasibility study, pointed out at the time that the risk associated with UTOPIA was not any less just because cities were pledging taxpayer money to back the project. "A cost of capital of 6 percent greatly understates the inherent risks of the investment by effectively ignoring the substantial risks that are shouldered by taxpayers," Fitzsimmons' report said. "Ignoring those risks, however, does not make them go away."

That is exactly right; you can disguise or hide risk (and costs) in the short-term, but eventually the chickens will come home to roost. That leaves UTOPIA's supporters with two options: stick it out or look to privatize. Utah Rep. Stephen Urquhart, who is a member of the state's Government Competition and Privatization Subcommittee, told Oberbeck that UTOPIA's financial results "don't look good. Right now it appears they're using one credit card to pay off another. And it seems all they're doing now is trying to play out their hand a little longer."

Thus, UTOPIA's managers could try to hold out a bit longer and see if take rates improve and help them gain financial stability. Alternatively, they could look to sell the assets already in the ground to a private company and cut their losses. Those facilities (especially the fiber) could still be used to expand high-speed offerings in the future, so the venture is not a complete loss for the cities or consumers. But some company will likely get those assets for much less than the going market rate since the UTOPIA project is in so much trouble, and that will strike some as unfair. But it's clear something will likely have to change, and soon.

This experiment, like the many other failed municipalization schemes of the past, should serve as a cautionary tale about the dangers of grandiose, centrally planned broadband schemes. Again, there is no such thing as a free lunch.

posted by Adam Thierer @ 9:27 AM | Broadband , Municipal Ownership