by Roland Montagne
After the example industry pioneers in Japan and the United States have set, more and more deployment projects for fibre-optic access networks have emerged in Europe, proving that this type of infrastructure appeals to operators. However, a number of issues still need to be addressed for such deployments to become common across the continent, particularly with respect to market outlook and return on investment. What lessons can be learned from the first projects launched? What are the key economic factors involved in very high-speed (VHS) networks? Which architectures are best suited to the different demographic configurations? To answer these questions, IDATE has analysed the main obstacle foroperators and the key factors in VHS infrastructure profitability.Key factors for VHS technology players
A preliminary assessment of current deployments indicates that service demand alone does not suffice; operators base their strategies on other factors-the first and foremost being investment. Deployment costs are high; the largest cost item is civil engineering, particularly in Europe. The two factors that follow are related to the structure of existing telecom networks in terms of competitiveness as well as demographics and dwelling-unit structure-each of these factors being multifaceted.
The type of operator also plays a vital role in decision making. The four main players engaged in current deployments are incumbents, alternative operators (including cable TV companies), energy suppliers (utility companies), and new entrants. Local governments venture into VHS on an investment level and more explicitly via the energy companies that they control, which is particularly the case in northern European countries.
Unlike the other operators, incumbents have the size advantage and all that comes with it: financial flexibility, access to passive infrastructures, and extensive client bases. For investors in other categories, the advantages are fewer, as many have less financial capacity (alternative operators) or need to build client bases (new entrants), which explains the major differences in their level of commitment (depending on the context of the country).
Using a detailed model, IDATE evaluated the impact that choosing one approach over another would have on the costs and revenues of individual company projects; we then consolidated these elements to evaluate the overall economics of VHS projects.
We have analysed four basic elements, which include technical conditions (structure of existing telecom networks), demographics (population density and dwelling-unit structure), deployment layout (level of coverage and deployment rates), and market conditions (ARPU, penetration and churn rates) to establish a model of reference for the various accounting aggregates. These financial aggregates were also calculated for greenfield developments, i.e., projects of entire distribution networks requiring development from the bottom up: from line equipment in central offices to subscriber terminals (excluding the pair of copper wires already installed in the sub-local loop in the case of FTTN+VDSL deployments).
The following are the main results obtained through our analysis:
• The costs of different FTTH technologies, particularly GPON and Ethernet point-to-point (E-P2P), are close in nature given that some costs offset others. For example, the larger investment in fibre for P2P solutions is counterbalanced by the lower cost of Ethernet electronic equipment. FTTN+VDSL approaches, on the other hand, present substantial savings; in large cities, capex can be reduced by 70% compared with the first two options. Bit rate potential is generally lower, particularly for the uplink, due to the distance between fibre-optic terminal point and the subscriber. Moreover, the cost to access the existing copper sub-loop for alternative operators represents an operating cost and not a capex investment.
• Dwelling-unittype has a large impact owing to density and to vertical structures (buildings). For FTTH, a population density increase from 4,000 to 8,000 people/km2 enables operators to save close to 30% on civil engineering and cable installation costs. The same type of savings can be made by choosing neighbourhoods having eight apartments per building on average as opposed to four (population density being constant).
• Coverage and penetration rates affect deployment costs and economic performance of operations in different ways. A slow coverage rate would enable operators to spread investment over a longer period of time; however, it would also reduce operating revenues. All conditions being equal, a slow deployment rate would reduce net cash requirements (measured by taking the lowest level of accumulated free cash flow) but would increase the time required to achieve a balance in operations (measured by the date that accumulated cash flows become positive). Investment is inversely correlated to the penetration rate: A penetration rate of 40% as opposed to 20% would reduce the amount of investment per subscriber by 45%.
• In the VHS industry, not all players are considered equal. Incumbent operators have both a marketing advantage (having a well established telecom client base) as well as advantages in terms of investment. They can reuse existing ducts for 70% of their new network (our calculation hypothesis), which would enable them to save an average of 40% of total capex, measured against greenfield developments. Alternative operators also have a marketing advantage, because they can easily position themselves in this new market. However, to reach financial equilibrium, these operators need to be able to access passive infrastructures (passageways, ducts, or dark fibre). In this context, financial equations at the end of a 10-year term are close to those of incumbent operators, who possess substantial assets. New entrants are in the same situation in terms of deployment. For utility companies, facilitated access to passive infrastructures is clearly one of the main reasons why they embark on VHS technology. Conversely, new entrants are at a disadvantage in this respect.
• The degree of competition is an important factor, influencing the economic balance of operations. Two front-running operators in a single national market would have a tougher time keeping afloat compared with a single operator, even though competition has a positive effect on market development. This is because positive accumulated cash flow only comes into play four years later. Regulatory measures could soften the blow as well as fend off monopolies. For instance, the wholesale market could be structured in such a way that would allow one operator to have additional revenue and the other to have access to the network without having to make a hefty investment. Or the weight of investment in passive infrastructures could be shared, which would improve economic stability.
Our model has also allowed us to measure investment and operating profits for large-scale network and VHS deployment.
To do this, we looked at the economy of a country as a whole, having a population of 60 million and 3 million small offices/home offices and small to medium enterprises, in which three operators (the incumbent, an alternative operator, and a retailer) offer access services on a GPON, each operator having an equal level of market share. In our simulation, we considered the context of gradual deployment-first targeting businesses in urban and suburban zones (100% coverage in these areas over 10 years) and subsequently in residential areas in year six. In this scenario, the total coverage achieved would be 54% (more than 15 million connectable outlets, of which 14 million would be in large cities and suburban zones) and an overall penetration rate of 25% (with more than 7 million subscribers).
The investment required over the 10-year term would reach:
- €8.3 billion for the incumbent operator (see figure), which can save on civil engineering costs because of its access to ducts. The incumbent is forced, however, to deploy connections beyond its retail client base to cater to the wholesale market.
- €6.4 billion for the alternative operator, which must cover leasing costs to access the passive infrastructure for its fibre network.
- €345 million for the retailer, which must cover terminal purchases and the costs involved in acquiring wholesale capacity (on a base price of retail minus 30%).
As for performance, based on an ARPU of €50 (taxes included for residential, plus taxes for businesses), free cash flow would become positive in year nine for the incumbent and in year 10 for the retailer. It wouldn’t be until after the 10th year that the alternative operator’s free cash flow would reach zero. For all three operators, accumulated free cash flow remains negative during the 10-year period, which is why operators chose the selective approach, deploying their networks in areas where the conditions governing access to passive infrastructures are attractive or in which high penetration could be achieved immediately.
We have also evaluated the FTTN+VDSL scenario not presented here. The economic equilibrium is much more favourable for the incumbent; the incumbent theoretically benefits, as seen in our model, from “free” access to the copper local sub-loop.
When analysing these results, one would also need to consider the more complex realities not included in our theoretical model, such as the industry of origin of the players, the regulatory context, and the state of existing access markets and their development. These factors affect the penetration levels, market share, level of offers, prices associated with these offers, etc.
There are many conditions that govern the level of profit operators can achieve through fibre network deployment, which may explain why investors are taking the cautious approach.
Opportunities to gain access to passive infrastructure remain a top-if not the primary-factor that operators take into consideration. This is the case for incumbent operators and energy suppliers (putting to work ducts that they own). Alternative operators and new entrants would need to share investment requirements via leasing passageways, ducts, or dark fibre.
Regulations have a diffused effect, whereas technical factors intervene primarily in connection with the size of the existing switched network, particularly in regards to the length of the local sub-loop, given that lengths exceeding 400 m cannot support VDSL.
Finally, operators define their investment strategies according to a number of factors: demographic structure, dwelling-unit types, and existence of broadband clientele bases.
Roland Montagne is head of broadband practice at IDATE (www.idate.org). He can be reached at [email protected].