City ponders its telecommunications options

City ponders its telecommunications options

The City of Palo Alto weighed its options carefully before it decided that a dark fiber ring would meet its strategy objectives.

STEPHEN HARDY, Editor in Chief

The spread of communications deregulation around the globe and a desire to expand the bottom line have led public utilities worldwide to consider the addition of telecommunications to their service portfolios. This trend is particularly acute in the United States, thanks in large part to the Telecommunications Act of 1996--although the introduction of competition into utilities provision, and the desire to recoup potential revenue losses in what were once captive markets, have no doubt provided a catalyst in some instances as well. Meanwhile, city and town officials have begun to recognize the importance of an advanced communications infrastructure to their communities` overall financial well-being. If they find themselves unsure that the local regional Bell operating company or a competitive local exchange carrier will construct the telecommunications networks necessary to attract new businesses to their part of the state, some officials have considered taking an active role to fill the perceived void.

These forces recently combined in Palo Alto, CA, where the city fathers decided to take the matter of telecommunications infrastructure into their own hands. How they reached this decision--and how they are using the City of Palo Alto Utilities (cpau) to implement their strategy via a dark fiber network--could provide a model for other cities and utilities pondering the best use of their assets and rights-of-way.

Think before you act

Palo Alto`s journey toward control of its telecommunications destiny began in May 1995, when the city council approved $135,000 for a five-phase study to identify and implement a telecommunications strategy that would best serve the city`s citizens and businesses. The five phases included situation analysis, market analysis, preliminary alternatives assessment, comparative analysis of alternatives, and business plan development. (This last phase was ultimately replaced by strategy implementation.) The city hired a consulting firm to conduct the study and established a Telecommunications Advisory Panel, made up of local officials and citizens, to assist the city staff in evaluating the consulting firm`s findings.

Nine months later, in February 1996, the city manager filed an interim report after completion of the third phase, the preliminary alternatives assessment. The report indicated that the city could play a role in telecommunications provision if it so chose. For example, the situation analysis revealed that the city had several assets that would simplify its entry into the telecommunications business. The city`s rights-of-way, combined with the cpau`s existing ducts and poles, were potentially valuable resources--either to a communications carrier looking to build a network in the city, or to the city and the cpau itself should it decide to build its own network. In addition, the city had an existing coaxial-cable infra-structure with a limited amount of surplus capacity that might be leased. Meanwhile, the cpau`s billing system provided the ability to consolidate charges for multiple services on customer bills while offering a natural opportunity to market city-provided telecommunications services should they become available.

Also, the researchers noted that the state regulations governing the entry of cities into the telecommunications market were significantly less restrictive than those governing private telecommunications providers. Also, local communications companies were examining their options under the Telecom Act, which promised an explosion in demand for bandwidth from new communications competitors.

Meanwhile, the market assessment provided a useful glimpse of the telecommunications demand within the city. The overall market for telecommunications was $60 million--about the same value as the market for electricity currently being served by the utility. By 2002, the telecommunications market was expected to grow to $85 million--or the size of the electric and gas utility markets combined.

Residential users composed roughly a third of the total market, with large and small businesses evenly dividing the remaining market share. The large number of businesses meant that a large number of telecommunications users might have both an interest and the financial wherewithal to lease communications bandwidth from the city.

Interestingly, the report also noted that while investing in telecommunications infrastructure potentially could reduce communications costs at city facilities, these reductions paled in comparison to the investments themselves. Thus, if city officials were looking for a justification for getting into the telecommunications business, saving the city money would prove a poor excuse.

Given the analyses of the city`s situation and the market it would be entering, what were the councilors` options? Phase 3 of the study, the preliminary alternatives assessment, highlighted four alternatives:

Lease the city`s existing infra-

structure--First, the city could lease its existing infrastructure--its rights-of-way and spare duct and pole space--to private telecommunications network developers and other businesses interested in establishing point-to-point communications links. It could also lease its surplus coaxial-cable capacity, although this opportunity was considered more trouble than it was worth, given the small size of the surplus capacity.

Develop a network and lease access--

Second, the city could build a network and lease access to it on a nondiscriminatory basis to service providers. In this scenario, the city would limit its role to providing the links between customers and service providers. A partner could be brought in to help build and market the network, or the city could choose to build the network and lease capacity on its own.

Develop a network and compete directly--

Third, the city also could build a network and market services and capacity directly to end-users--in other words, jump into the service provision field with both feet. Again, the city could find a partner or pursue this strategy independently.

Do nothing--Last, the city could adopt a

laissez faire approach to telecommunications and let the free market determine when and how communications infrastructure would be constructed within the city.

The task force that assembled the report noted that leasing the existing infra-structure presented an opportunity to generate revenues from existing assets with little or no financial risk to the city. The report recommended that this option be studied further. The report also recommended further study of the second option. Not only would it generate revenue, but it would foster competition within the city among experienced service providers who might otherwise be discouraged from entering the Palo Alto market because of the high cost of building infrastructure. The opportunity to have some of these companies provide services directly to the city was also noted.

On the other hand, the interim report recommended rejection of the last two options. While it promised the highest earnings potential, the direct competition option would require the greatest financial investment and more telecommunications expertise than the city possessed. It also would not foster as much competition as the other two options. Meanwhile, the researchers felt that the "do-nothing" strategy would cause the city to underutilize and undervalue its existing assets. The report concluded that at the very least, the city should lease its existing assets and properly manage the public rights-of-way so that they would provide the maximum benefit to the Palo Alto community.

Thus, the interim report laid the groundwork for Phase 4, the comparative assessment of the favored options. With city council approval, the two alternatives would be evaluated by how well they achieved the following five objectives:

accelerated deployment of advanced

broadband telecommunications services to all of the citizens and businesses of Palo Alto;

decreased costs for both conventional

and advanced telecommunications services (as compared to the costs for such services if provided without the city`s involvement);

promotion of high quality for conven-

tional and advanced telecommunications services;

enhanced competition among telecom-

munications service providers and increased telecommunications choices for consumers;

limited or no financial risk to the city.

Weighing the options

The city council approved the report`s recommendations, and Phase 4 was launched. This part of the study involved five steps: an assessment of the city`s strengths and weaknesses relative to competitors; meetings with telecommunications managers from Palo Alto corporations, and representatives from the Palo Alto Unified School District and a citizens group; issuance of a request for information (rfi) to telecommunications service providers; a qualitative evaluation of potential telecommunications strategy variations; and a quantitative evaluation of specific strategy implementations.

This phase of the study lasted until the following June, when a report on Phase 4 was delivered to the city council. Again, the results were encouraging. Taking the study steps mentioned above in order, the report highlighted several strengths that would help the city get involved in telecommunications. Physical assets such as the poles and conduit owned and operated by the cpau as well as the coaxial-cable system can be considered the first strength. The poles and ducts were determined to have ample space for the laying of additional cable. The city`s and the cpau`s existing buildings were determined to be adequate to house the necessary telecommunications and power equipment for a potential new network. The cpau also had the equipment necessary to install cabling in the existing conduit or along utility poles. Existing mapping and geographic information system equipment also would prove useful in network planning and maintenance. Finally, the cpau`s billing system was deemed adequate to handle telecommunications services billing, as well as to provide a marketing avenue to customers via the inclusion of promotional material with the customers` monthly electric bill.

The city and the cpau also possessed several core competencies that would prove useful in the telecommunications arena. First was the cpau`s experience with the development of both overhead and underground cable infrastructure for electric distribution and internal communications over coaxial and twisted-pair cable. Although the cpau had little experience with fiber-optic cables, it was determined that a limited amount of training could bring technicians up to speed on the necessary installation skills. Second, the cpau obviously also had experience with placing equipment within city limits. Third, the cpau also had gained some market experience in a competition-based environment through the recent introduction of competition into utilities provision. Existing strong relationships with utilities customers should help in marketing telecommunications services, the Phase 4 report stated. And fourth, the city`s experience in providing electricity at a cost-based rate below that of its private-sector competition would prove an asset in competing within the telecommunications arena. The city would be able to remain cost-competitive by establishing rates with smaller returns than those demanded by private-sector competitors, the Phase 4 report reasoned.

Balancing these strengths were several weaknesses derived from the fact that the city had no experience providing commercial telecommunications services. Of course, the city had recognized this previously in discarding the direct competition option. Nevertheless, while these weaknesses would have less effect in the two options under review, they were worth noting. They included:

The problem of customer confidence--

Service reliability is critical, of course, particularly to business users. Could the city convince such users that it could provide services with the necessary reliability without a proven track record? The researchers were unsure--although, depending upon what kind of services were being considered, the addition of a reputable partner or leaving service provision to communications carriers leasing bandwidth would overcome this potential hurdle.

New entrant--Similar to the first weak-

ness is the fact that the city would be a new entrant to the market and would have to wrest market share from established competitors such as Pacific Bell. Thus, the city`s infrastructure would have to be highly reliable and priced below that of incumbent infrastructure providers for this new endeavor to be successful.

Limited geographical scope--The city`s

service area is also naturally geographically confined to the city limits--which, of course, is fine until someone wants to call out of town. The fact that the network would both begin and end within the city meant that economies of scale enjoyed by such competitors as Pacific Bell would not be available to the city.

No profit motive--Fourth, as public enti-

ties, the city and the Utilities Department lack a profit motive and have a certain "corporate culture" that tends to be averse to taking the kind of risks frequently necessary to achieve high payoffs. Thus, the revenue potential from getting into the telecommunications field would probably be less than it could be.

Public decision process--Finally, as a

government entity, the city makes decisions via public process--which can be a drawback in a market environment that frequently requires quick and potentially publicly unpopular decisions. Again, with the advent of competition in the provision of utilities, the Utility Department was gaining experience with adapting to this paradigm. Also, the Phase 4 report noted that joining with a partner to which some decision-making could be delegated might help the city`s position.

In the second step of Phase 4, the city met with telecommunications managers from local corporations and representatives from the local school district and a citizens group to discover their communications needs and how the user community might feel about the city`s entry into telecommunications. In general, all these groups said that the city had a role to play in telecommunications--but opinions were mixed as to what that role should be.

The third step in Phase 4 of the study involved contacting the local service providers--who would be the city`s major potential customers--to gather information on their requirements and their receptiveness to the idea of having the city as a telecommunications partner. The researchers also asked for information regarding the service providers` preferences for various city infrastructure lease and network development options, as well as for the different types of business relationships that the city might pursue.

The city received responses from six of the fifteen companies targeted by the rfi. Not surprisingly, four of the six respondents said their preferred option would be for the city to grant them exclusive access to the city`s infrastructure for the purpose of developing their own networks. This, of course, would limit their competition to existing service providers and new entrants that would have to develop redundant infra-structure. Failing that, however, these same respondents expressed an interest in leasing dark fiber, provided it reached the right locations at the right price. The other two respondents said they were interested in having the city build a fully functional network on which the companies could lease access for a minimum investment.

The study next compared and contrasted the two primary strategy alternatives. The major difference between the two options was determined to be the amount of control the city could exercise over the development of telecommunications facilities in Palo Alto. Generally speaking, the city had more control if it built a network than if it leased its existing infrastructure, although how much control was available in each scenario could be increased or diminished.

Finally, the researchers performed a quantitative analysis of the two options. Because the city council was less concerned with making a financial killing than it was with maximizing the benefit delivered to the community--subject, of course, to the constraint of minimizing the city`s financial risk--this analysis focused on risk assessment and expected return.

In examining the two alternatives, the researchers segmented the network development option into four variations: a dark fiber backbone with dark fiber extensions for use by a potential telecommunications partner; a dark fiber backbone with no extensions; a competitive access provider network (in essence, a fiber-to-the-building network that would provide links to major telecommunications users within the city, complete with electronics) with dark fiber extensions for use by a potential telecommunications partner; and a competitive access provider network with no partner.

The analysis included estimates of the net present value of projected cash flows from each option over a 10-year period, as well as risk assessment via a variety of models and simulation techniques. The bottom line is that the "lease existing infrastructure" option provided almost no risk, but relatively small return as well, with less control over the resultant telecommunications facilities. The dark fiber options also had little risk, but offered greater returns, while the competitive access provider network options presented both the greatest risks and the greatest potential reward.

In its conclusion, the Phase 4 report recommended the construction of a dark fiber backbone that would enable the city to pursue either of the dark fiber strategies that had been studied. Such a strategy would maximize the benefits to the community and meet the five city council objectives. The researchers also said that developing a ring of dark fiber would enable the city to focus its telecommunications activities directly on its key competitive advantage: the cpau`s ability to rapidly construct a route-diverse fiber ring without incurring the high cost of boring underground and installing new conduit. By independently developing the ring, the utility would maintain exclusive control over its infrastructure and situate itself in a position of strength from which it could use the fiber to the community`s greatest benefit.

Construction of the network would cost under $2 million, in the report`s estimate; this cost was deemed significantly smaller than the potential resale value of the fiber, thus leading the researchers to consider this option relatively low in financial risk. However, while the actual construction costs of the network were estimated to be under $2 million, related costs--such as salaries, training, consulting and outside services, and a contingency fund--led the researchers to ask for total funding of $2.24 million. After construction was completed, ongoing costs were estimated to be $250,000 per year.

The report then estimated that based on what it termed "reasonable lease assumptions," the construction costs could be recouped within three to five years; after that, the report anticipated a mature net cash flow in excess of $1 million each year.

String it out

The report convinced the city council that it could play a role in providing advanced communications services to Palo Alto citizens and businesses, and that a dark fiber ring provided the best way to fill that role. Thus, the cpau began construction in January 1997 of a 28-mi dark fiber-optic ring around Palo Alto (see figure). To date, 24 mi of the ring`s total 28 mi have been completed. Two of the remaining 4 mi will be in place by the end of this summer, with the last 2 mi held in reserve to meet future demand. Initially, the utility launched the construction by itself; however, an unexpected short-staff situation led them to hire a contractor for five months to keep the project going. According to Van Hiemke, telecommunications manager for the cpau, 99% of this cable was installed using existing infrastructure. The cable contains 144 to 288 strands of singlemode fiber--plenty of capacity for leasing.

The city has already begun to see a return on its investment. Brooks Fiber Communications licensed a portion of the ring in May 1997 to connect customers on its existing network south of Palo Alto to the Internet Exchange run by Digital Equipment Corp. in downtown Palo Alto. The first end-user customer came aboard the following October, when Web TV leased bandwidth to build a private network to link five facilities downtown and also gain access to the Internet exchange.

The cpau is on its way to making a success of its telecommunications venture. While the city`s situation is unique in many ways, the process by which it developed its telecommunications strategy--the establishment of goals, the examination of its assets and liabilities, the conducting of market research, and the evaluation of network options--could easily be followed by other cities or utilities pondering whether telecommunications provision is the wave of the future for utilities--or this year`s Pet Rock.

The City of Palo Alto is putting the finishing touches on a 28-mi dark fiber ring, the result of a thorough review of its telecommunications options and assets. Initial estimates predict that the network, which contains 144 to 288 strands of singlemode fiber, will pay for itself within three to five years.