By Mitch Shapiro

Has that much-maligned Cable Guy transformed himself into a Broadband Behemoth ready to compete in the marketplace against ILECS, DLECs, CLECs, ISPs and ASPs? Or, as some ISPs and local broadcasters claim, is he really just a Broadband Bully using his local access bottleneck to compensate for a lack of prowess in open competitive markets?

AT&T, now the nation’s largest cable operator, is promoting the first image in its new "Boundless" ad campaign, which introduces consumers and businesses to "AT&T’s Broadband World." But the company’s unimpressive operating performance in broadband thus far and its savaged stock price suggests that Wall Street, among others, have yet to be convinced. Nevertheless, current and future competitors (many of whose own stocks have also been pummeled this year) would be unwise to dismiss cable as a competitive force based on a superficial reading of AT&T’s much publicized woes and the cable industry’s decades-old image problems.

Two key factors play to cable’s advantage in the broadband wars. First, and most fundamental: cable is the only broadly available facilities-based alternative to ILECs in the residential and, to a lesser degree, the small business market.

Secondly, cable has so far been able to avoid the common carrier status that requires ILECs to make their facilities available on fair and equitable terms to competitive service providers. As a result, cable’s affiliated ISPs (mainly @Home and Road Runner) today provide the only cable-based broadband offering available to their customer base.

As a point of comparison, consider that DLECs account for roughly one in five DSL customers (see sidebar) and that one in four Qwest DSL customers chooses an ISP other than Qwest’s affiliated ISP, Qwest.net.

Under mounting political pressure, especially since the planned AOL-Time Warner merger began focusing attention on key competitive issues, most large cable operators have expressed their intention to end these exclusive ISP relationships in the 2001-2002 timeframe. After sidestepping the issue for most of this year, the FCC in September finally launched a proceeding on "open access" to cable networks. At the same time, the agency, along with the FTC, was continuing to study the competitive impacts of the AOL-Time Warner merger.

The FCC’s long-awaited move on open access followed a U.S. Court of Appeals decision ruling that cable-delivered Internet access is not subject to local government regulation as a "cable" service. A key question not clearly addressed by the court, however, was whether this service should be treated like a "telecommunications" service or an "information" service. If the latter, a minimalist approach to regulation would seem to be in order. If the former, a stronger case could be made for a common carrier-like regulatory regime, though FCC chairman William Kennard has indicated that this need not include all common carrier regulations applied to telephone companies.

Common carrier-style regulation would be a major blow to cable’s "walled-garden" vision of the broadband future. Though MSOs have come to realize that their future business models must take into account the Internet’s open and free-wheeling nature, they hope to restrain its most extreme tendencies, including hyper-competition and painfully thin or negative margins. The way they plan to accomplish this is by leveraging the combined power of: 1) an AOL-like strategy that provides a walled-garden of proprietary content, technologies and services and; 2) their own bottleneck control of one of only two dominant access networks.

Historically, cable operators have operated under a set of regulatory rules that allows them to take competitive advantage of their gatekeeper roles more overtly than ILECs. Though subject to limited non-discrimination rules regarding cable programming, MSOs for the most part get to pick and choose what programming is carried on their networks and where on the dial each service is placed. And in cases where regulation requires carriage—e.g., the "must carry" rules applied to local broadcast stations—there are still important limits on how far cable operators must go in accommodating rivals. For example, data services imbedded within the signals of must-carry TV stations can be stripped out and replaced by cable operators as long as the content of these data services is not directly tied to the TV programs being transmitted.

Recent statements and actions by Time Warner and AOL on the open access issue highlight the nature of cable’s walled-garden strategy and its implications. While assuring regulators they will provide competitive ISPs with open access to Time Warner’s cable networks, the initial deals offered to such competitors are a far cry from what one might expect under a common carrier regime. According to reported statements made by several competitors, AOL/Time Warner has offered to provide them with access to its local network in exchange for the following: 1) 75% of subscription revenue; 2) 25% of advertising and e-commerce revenue; 3) veto control over the content of ISP home pages and a permanent and prominent ad on these home pages.

Cable’s walled-garden strategy also has some key technical components, some with important ties to developments on the regulatory front. The next generation of the DOCSIS cable modem standard (DOCSIS 1.1), to be deployed next year, is a good example. The potential good news for competitive ISPs is that new DOCSIS 1.1 platforms will readily support multiple-ISP open-access arrangements. The bad news is that they will also allow cable operators to monitor and control traffic on their networks down to the packet level.

This means that DOCSIS 1.1 will give MSOs the technical means to favor their own content and services and capture a slice of virtually every revenue stream devised by competing service providers that ride on their networks. If we assume, as many do, that the broadband industry is entering an era of explosive growth in new services and revenue streams, this has powerful implications for the future competitive landscape.

So, depending upon how things unfold in the regulatory arena, DOCSIS 1.1 could become a potent tool for implementing and enforcing a common carrier-like open access regime, or an equally powerful tool enabling cable MSOs to play an unprecedented role as broadband toll-collectors.

DOCSIS 1.1 has other competitive implications as well. By supporting Quality of Service, SLAs, IP-telephony, enhanced billing, management and provisioning functions, as well as carrier-class reliability and scalability, second-generation DOCSIS platforms will give MSOs key tools for delivering a range of new IP-services to both the residential and business markets (Note: next month we provide a closer look at cable’s strategies and initiatives in the small-to-medium business market).

Amidst continued fragmentation in the DSL standards arena, the DOCSIS standard, especially version 1.1, could also prove a key weapon in cable’s fight to retain the leadership role in bringing broadband to the masses (see sidebar) and in the race to bring CPE to retail shelves.

Another technical piece of cable’s broadband strategy is tied to its pursuit of a bundled service strategy. To better leverage this strategy from a technology perspective, the industry is beginning to deploy next generation set-tops that provide substantial CPE cost savings for the delivery of multiple bundled services. They do so by integrating a DOCSIS modem and IP-voice capability inside a high-powered box that also delivers video-on-demand, interactive TV and Internet access to the television. In cable’s vision of the future, these multi-service gateway devices will, in effect, be set-top toll-booths for companies seeking to set up shop within cable’s walled garden or to otherwise gain access to its customer base.

As the MSO farthest along in offering its customers a full bundle of services (see Tables 1 and 2 ), Cox provides a good example of how cable’s economics are starting to change.

Companywide, Cox at mid-year was experiencing 9%, 6% and 10% penetration of "service-ready" homes for digital video, high-speed-data and telephony. Of its local telephone customers, roughly 75% also sign up for Cox’s long distance service.

Cox’s Orange County system, which had launched all three services by the end of 1997, provides a sense of where the company as a whole might be in a few years. In that system, penetration rates among marketed homes at the end of first quarter 2000 were 20% for digital video and voice and 23% for high-speed data.

Cox’s one-time direct marketing costs have been averaging about $25 for digital video, $65 for high-speed data and $45 for telephony, which yields a weighted average of $40 per new revenue generating unit (RGU). In systems providing all three services, Cox offers an extra $10 per month discount for those who subscribe to all three.

At mid-year, 13.3% of homes in systems offering all three services subscribed to at least two of them, up from 9.7% at the end of 1999. In San Diego Cox recently offered its three-service bundle to 15,000 non-customers. Of these, 8.4% signed up for at least one service, with the average being 1.6 services per customer.

As a percentage of total RGUs, digital video, high-speed data and telephony accounted for 54%, 30% and 16%, respectively, during the second quarter, generating an average of $16, $28 and $60 per sub in monthly revenue. This equates to a weighted average revenue of $27 per RGU.

As deployments and penetrations grow, high-speed data and voice are becoming significant contributors to Cox’s revenue mix. During the second quarter, cable telephony accounted for 5% of the total, with data contributing nearly 4%.

As MSOs race headlong into the broadband future, numbers like those in Orange County are the sweet carrots they are chasing. The stick, which seems to hit a bit harder each quarter, is the mounting competition from DSL, satellite, fixed wireless and a new generation of "overbuilders," plus the looming regulatory threat to their walled garden strategy. Though they may stumble along the way, expect them to keep running hard and fast…and watch out for those elbows.

Sidebar: The Road From Cable TV to Broadband

Though cable’s top MSOs are all pursuing a bundled-service broadband future, there are some notable differences in the pace and the path they are travelling (see Table 2).

Table 2: Cable's Big Six*

At mid-year only two of the six (Cox and AT&T) were delivering residential telephony, with the rest planning to wait until IP-telephony is ready for prime time. Both Cox and AT&T, as well as Time Warner and Adelphia, also provide services to the business market. The latter three do so through a separate CLEC subsidiary, while Cox Business Services is more closely tied to its cable business and focuses mainly on customers that can be served by the company’s cable plant (Note: next month we provide a more detailed discussion of cable’s business market agenda).

As it digests its two huge cable acquisitions—TCI and MediaOne-- AT&T must deal with the fact that the two companies had initially pursued different paths to broadband. Whereas TCI’s initial focus was on a rapid nationwide rollout of digital video, MediaOne was relatively slow to invest in first-generation digital set-tops. Instead, it focused on high-speed data and, to a lesser degree, residential telephony. Tied to these differences in strategy was the fact that MediaOne was much further along in upgrading its plant for two-way services and, at the time, was owned by RBOC US West.

Time Warner was relatively late getting into digital video, but has since moved very fast on this front, and is now a leader in the early deployment of video-on-demand. It was also among the first to aggressively roll out high-speed data. The company’s ability to quickly deploy these services is due in part to the fact that it was relatively early and aggressive in terms HFC network upgrades. It has also been less active than its peers during the past few years in terms of acquisitions, which means fewer new systems to integrate into an already heavy construction schedule.

Like TCI, Comcast’s initial focus was mainly on digital video. But with a higher percentage of upgraded plant, it was also able to move fairly quickly on high-speed data. As of mid-year only AT&T and Comcast enjoyed double-digit penetration rates for digital video among their subscriber base.

Adelphia and Charter, both which have experienced explosive growth in their cable holdings—including a lot of systems needing network upgrades--were initially relatively slow to roll out both digital and high-speed data, in large part because they have had their hands full digesting and upgrading these acquisitions. Charter, however, has since become very aggressive in its digital video deployment.

Though cable was first out of the gate and retains a significant lead compared to DSL in bringing broadband to consumers, there are signs that the gap may be closing (see Table 3).

During the second quarter of this year the four largest ILECs (SBC, Verizon, BellSouth and Qwest) plus the three top DLECs together added 408,700 DSL customers to their rolls during the second quarter, slightly more than the nearly 401,000 cable modem customers added during the same period by the six major cable MSOs, which collectively reach roughly 88% of the nation’s homes. This compares to the first quarter of the year, when new cable modem subscribers topped new DSL customers by more than 50%.

Looked at another way, the pace of cable modem activations increased by a mere 2% from quarter to quarter while the corresponding growth in DSL activations jumped 60%. The latter breaks out to a 25% increase for the three top DLECs and a whopping 71% rise for the top four ILECs.

If we dig below these industry totals, we find that the biggest component of this differential is linked to the two companies claiming the largest broadband customer base in each competitive camp: AT&T Broadband which at mid-year claimed more than 689,000 cable modem customers (34% of the Top-Six MSO total), and SBC, serving 399,000 DSL customers (36% of the DSL total) at the same point in time.

From the first to second quarter, AT&T’s pace of new additions dropped 17% from 149,000 to under 124,000. SBC’s quarterly activations, meanwhile, jumped 130%, from 86,100 to 198,000.

AT&T’s sagging numbers appear to reflect its other intense priorities and problems: a high-stakes launch of cable telephony, the integration of its MediaOne acquisition and other large systems, massive management turnover, a beleaguered stock, and growing doubts about its overall strategy and future prospects.

Other cable operators, facing these challenges to lesser degree, if at all, fared better. Nevertheless, among Time Warner, Comcast and Cox--which together accounted for another 56% of cable’s mid-year totals--none experienced double-digit growth in quarterly activations.

In contrast, the major DSL providers all experienced double-digit growth. Their improving performance suggests that the expansion of DSL self-installation programs and price cuts aimed at matching cable rates are having some effect. And though there are still plenty of horror stories about delays and confusion in the process of turning up DSL service, there are also some signs that much-needed improvements in provisioning are being implemented.

Consider SBC’s recent performance. An analysis of sales and activation data reported by the company suggests it built up a DSL order backlog of roughly 100,000 by the end of first quarter 2000, a quarter in which it sold 132,000 DSL lines but installed only 86,000. By the end of the second quarter, during which it activated 189,000 DSL lines, its order backlog had been cut to roughly 40,000.

When we evaluate the two industries’ push toward self-installation, its important to remember that there are a lot more phone jacks than cable-hook-ups within easy reach of home computers (all the more so in the business market). This suggests that cable operators may have a tougher time eliminating one of the key factors driving costs and delays: expensive truck rolls for broadband installations.

To understand where cable is headed, it helps to understand where its been. The industry’s history has been marked by:

1. a virtual monopoly in the multichannel video market in which a chummy club of "local-monopoly entrepreneurs" rarely faced competition, especially from each other;
2. relatively slow but steady channel expansion accompanied by rate increases well above inflation interrupted by occasional rate caps or cuts imposed by regulators;
3. relatively slow changes in technology and service offerings, longstanding vendor relationships with a handful of dominant suppliers and a lack of industrywide standards for key technologies such as set-top boxes;
4. fragmented holdings, with a single geographic market often split among many operators, an industry trait dating back to the early days of cable franchising;
5. a widespread--though not universal—reputation for mediocre-to-poor customer service and;
6. steady, predictable growth in subscribers, penetration and cash flow (again, subject to regulatory actions in response to perceived rate-hike abuses).

During the past decade, these longstanding dynamics have undergone an accelerating process of change. The process began early in the decade, with the introduction of hybrid-fiber-coax architectures and their promise of two-way services and greater reliability. By the end of the decade that promise was being tested in numerous markets around the country as cable, spurred by the 1996 Telecom Act and exploding Internet usage, began actively pursuing new "broadband" business models that encompassed not only broadcast video, but also high-speed data, voice and new interactive services aimed at both the PC and the TV.

On the technology front, MSO’s have made it a priority to launch new services using platforms based as much as possible on non-proprietary industrywide standards. Under the auspices of CableLabs, an industry-backed R&D consortium, and with some prodding from the FCC, the industry has been developing standards for cable modems (DOCSIS), digital set-tops (OpenCable) and next-generation IP services such as telephony and multimedia conferencing (PacketCable).

Cable’s mix and concentration of ownership has also changed dramatically during the past few years. At the end of 1998, the top six MSOs controlled roughly 67% of the nation’s cable customers. Today that figure is closing in on 90%.

Faced with the choice of "get big (and get broadband) or get out," many of cable’s old guard have exited the business, most of them smiling happily on their way to the bank. Whereas cable systems changed hands for $1,500-$2,500 per subscriber just a few years ago, the past year has seen prices roughly twice this level.

During the past few years of massive consolidation, the cable industry has attracted new owners with different strategic agendas and less allegiance to the industry’s implicit "non-compete" agreement. Whereas competitive overbuilds were historically shunned within the community of cable’s top owners, both AT&T (now the industry’s largest MSO) and Paul Allen (whose Charter Communication is the fourth largest MSO) have placed significant bets not only on cable but also on competing broadband platforms. AT&T has announced and begun implementing plans to deploy broadband wireless services in markets in which it does not have cable systems, while Allen has invested in RCN, the nation’s largest and best-funded overbuilder.

Its massive M&A activity, combined with extensive system trading among the major MSOs, has gone a long way toward reversing cable’s historic and debilitating fragmentation. This development of local system "clusters" has been viewed by MSOs as an essential step to achieve the necessary scale economies in capital and operating costs and advertising to compete in the broadband marketplace.

At the same time, however, the industry’s massive ownership change has brought with it some growing pains. These have included culture clashes and loss of key talent in the management ranks and challenges and delays related to technology and operational aspects of network upgrades and new service launches.