BTOP’s Fiber Investment, Social Value & the Special Access Market

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April 7th, 2016

During the past few days I’ve been: 1) reviewing the BTOP program evaluation study’s final report prepared in 2014 by ASR Analytics and; 2) doing some homework aimed at better understanding issues related to the FCC’s pending special access study and proceeding. The former relates to a pending Quello Center research project, while the latter was prompted by release of a paper written by Mark Cooper, Director of Research at the Consumer Federation of America (CFA).  Cooper presented the paper, entitled “The Special Problem of Special Access: Consumer Overcharges and Telephone Company Excess Profits,” at an April 5 event sponsored by the New America Foundation.

In his paper, Cooper made a theoretical and empirical case that “large incumbent telephone companies have engaged in abusive pricing practices” for special access services that have resulted in economic harm exceeding $150 billion over the past five years:

Today, special access is a $40 billion per year business, which works out to about $300 per household, which is almost equal to what they spend on landline telephone service…

This paper shows that about half of the total bill paid to the large incumbent local phone companies for special access service, who control between five-sixths and nine-tenths of the special access market, is the result of the abuse of market power – i.e. setting prices far above costs to earn excess profits…

Because of the importance of special access as an intermediate good, the $20 billion in annual overcharges suppresses a significant amount of economic activity, reducing economic output by at least another $20 billion. The magnitude of the harm has been growing steadily, so that the cumulative value of economic losses over the past five years is in excess of $150 billion.

While there’s much to consider and debate in Cooper’s analysis and, more broadly, related to the FCC’s pending special access proceeding (something that may be done in the future by me and/or MSU colleagues on this blog), for now I’m only going to use Cooper’s general argument as a jumping off point to consider a few metrics that struck me in ASR’s BTOP evaluation study.

As explained in the introduction to its final report, published in September 2014, ASR Analytics summarized the scope of and general methodologies used in its study:

The scope of work includes an assessment of the benefits that BTOP grants are having on broadband availability and adoption, and in achieving social and economic benefits in areas served by the grantees…

ASR developed its conclusions based on a mixed- methods approach that includes comparative case studies of BTOP-funded projects, input-output analysis of the short-term economic impacts of all BTOP budgetary spending, and a matched-pairs analysis of the counties served by infrastructure grants in the evaluation study sample.

The ASR study had lots of ground to cover and, in my view, did an admirable job of using mixed methods to leverage available qualitative and quantitative data to evaluate a large number of projects spanning three major categories: Comprehensive Community Infrastructure (CCI), sometimes referred to as “Middle Mile Fiber” projects, Public Computer Centers (PCCs) and Sustainable Broadband Adoption (SBA) projects. And, importantly, as ASR noted in the introduction to its final report, it was “required to provide NTIA with all data that created a foundation for the [report’s] analysis and conclusions, as well as all data that could be utilized by future researchers.”

In this blog post I’m going to focus on a few elements of ASR’s analysis of the impacts of CCI projects, whose purpose and nature are, in my view, closely tied to the issues surrounding the special access market. This is because most if not all CCI projects involved construction of fiber networks providing high-capacity, high-reliability connectivity to “community anchor institutions” (CAIs), including schools, libraries and government and healthcare facilities, as well as providing non-discriminatory open-access backbone connections to wholesale and last mile service providers.

As I see it, the BTOP CCI projects represent a significant wave of new players entering the special access space, the bulk of whose construction costs (up to 80%) were covered by federal grants, and whose terms of service are required to meet certain nondiscriminatory “open access” requirements. And, conveniently and importantly, thanks to NTIA and ASR, these projects have been the subject of careful study from their inception.

Though there’s plenty we can learn from the ASR study of CCIs, I’m going to focus here on some high-level numbers that the study gathered, estimated and extrapolated.

According to Table 7 on pg. 15 of ASR’s final report, the total amount (including both federal grants and matching funds) budgeted for 109 CCI projects was $3.9 billion. The table also indicates that, at the time the study was done, these projects had connected 21,240 CAIs, at a budgeted cost of $184,141 per CAI. Assuming federal grants paid for 80% of this total cost, the average federal grant amount per CAI would be in the neighborhood of $147,300.

Table 13 on pg. 34 of the report shows the changes in subscription speeds and pricing experienced by the 86 CAI locations providing this information to ASR. The table shows very large increases in speed and, depending on the category of CAI, dramatic 94-96% average reductions in per-Mbps pricing.  Table 14 on pg. 36 uses these reported changes in speed and price to extrapolate CAI cost savings from switching to CCI-provided fiber connections. Averaged across all CAI categories, the per-CAI annual savings amounted to $236,151.

So, in a single year, the average CAI saved well more ($236,151) in operating costs than the total capital cost ($184,141) required to connect it to a CCI fiber network.

These direct cost savings to CAIs were only part of the impacts considered by ASR. It also used previously developed models to estimate other economic benefits, as explained on pg. 33 of its final report:

Increased economic output: The largest long-term social or economic impact due to BTOP infrastructure spending is the yearly increase in GDP in the areas served by the new broadband infrastructure. ASR used two studies, Czernich et al. (2011) and LECG Ltd. (2009), to extrapolate the increase in economic output that could be expected in counties receiving BTOP- funded infrastructure. For the base case of a 2.0 percent increase in broadband availability, BTOP infrastructure spending could be expected to yield $5.7 to $21.0 billion in increased output annually using results from Czernich et al. (2011) and LECG Ltd. (2009) as the bases for extrapolation, respectively.

Long-term increased levels of employment: Kolko (2010) and Gillett et al. (2006) provide a basis for estimating the long-term increase in employment due to BTOP-funded infrastructure spending. Based on Kolko’s estimates, the additional broadband infrastructure provided by BTOP could be expected to create more than 22,000 long-term jobs and generate $1.1 billion in additional household income each year. Results from Gillett et al. (2006) suggest at least 6,900 long-term jobs could be created in the year following the construction of BTOP infrastructure, and potentially each year for at least the next four years due to increasing employment growth in areas with new broadband availability. These employment increases would result in a $328 million increase in household income for each year employment increases by the estimated amount in newly served areas.

Value to new subscribers: The Allen Consulting Group (2010) finds the value of broadband Internet access to the average American household is about 3.4 percent of average household income. Using the base case to determine the number of households adopting broadband, this translates into an estimated value of broadband to new subscribers of $2.6 billion per year.

Given all of the above, the CCI component of NTIA’s BTOP program strikes me as a very good investment of public funds in that it: 1) delivers substantial direct and indirect net social value, as suggested by the ASR study and; 2) helps correct the substantial excess-profit market failure suggested by both the CFA analysis and the dramatic cost savings reported by CAIs after connecting to BTOP-funded CCI fiber networks.  And given these strong indicators of net social value, I’d suggest that the federal government consider expanding its CCI investment in geographic areas that the FCC’s special access data collection project indicates still face a lack of competitive options and an abundance of excess-profit-extracting prices in the special access market.

I’ll have more to say about this perspective in future posts.

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