by Mitch Shapiro

As they race to offer new broadband services to their residential customers, cable operators are also taking aim at the small-to-medium businesses (SMBs) within their franchise areas.

This is no surprise, given the potential size of SMB broadband revenues and the fact that cable networks, though built to serve residential areas, also pass a significant portion of what many believe is an underserved SMB market. And, as some operators are finding, an even larger share of this market can be reached via line extensions that can be economically justified by new SMB broadband revenue streams.

Recent studies shed some light why the SMB broadband potential is attracting cable’s attention. AMI-Partners, a research firm specializing in SMB markets, pegs 1999 spending on IT, Internet and telecommunications by U.S. SMBs at $250 billion. That’s roughly seven times the cable industry’s total annual revenues.

According to IDC, small businesses (5-99 employees) and SOHO businesses (1-4 employees) spent $19.6 billion on building their Web presence in 1999, 26% of all business web spending. IDC expects this figure to grow to $85.5 billion and 35% of total web spending by 2003. The Yankee Group, meanwhile, estimates that businesses with up to 500 employees spent about $4.4 billion on hosting services, a market it projects to grow to $14.4 billion by 2003.

According to IDC, more than 57% of the SB/SOHO market had Internet access in 1999, while Cahners In-Stat expected more than 80% of SBs and nearly 75% of SOHOs to be online by the end of 2000.

According to AMI, 72% (113,000) U.S. MBs and 23% (1.7 million) of SBs have a web site, and 19% and 35% of these, respectively, use their site to conduct e-business. IDC predicts that the number of small businesses engaged in e-commerce will reach 2.8 million by the end of 2003.

But while U.S. SMBs are increasingly wired to the Internet, the penetration of broadband remains low. AMI found U.S. SMBs to be "seriously lagging" behind Germany and Japan when it came to high-speed access. Whereas 59% and 40% of German and Japanese SMBs had high-speed access in 1999, only 21% did so in the U.S. IDC estimates that only 9% of U.S. firms with less than 100 employees had high-speed access in 1999 vs. 48% that relied on dial-up modems. Since these studies appear to have included ISDN in the high-speed category, we assume that penetration for true "broadband" access technologies (DSL and cable modems) was substantially lower than the figures cited by AMI and IDC.

IDC data points to a strong relationship between high-speed access and establishment of a web presence. Whereas only a third of all Internet-using SBs had home pages, the corresponding figure was much higher--72%--for those with high-speed connections.

Taken together, these statistics suggest a small business market already heavily wired to the Internet via narrowband links and with a growing appetite for a more advanced broadband-enabled capabilities.

This potential has caught the attention of cable operators, who hope to use the broadband platforms they are developing to serve residential customers to also become the provider of choice for SMBs. Their goal is to provide SMBs with broadband access and, as they roll out second-generation DOCSIS platforms and beef up their product line and service capabilities, to augment this with web hosting, ASP, remote access, VPN and other value-added services that increase per-customer revenues and margins.

As Stephen Burke, President of Comcast Cable Communications put it recently: "We have more bandwidth than anyone deeper into our infrastructure, and this is exactly what small and medium-sized businesses want."

And though cable’s reputation is less than stellar in many markets, MSOs do have significant brand ID, with many SMB decision-makers also residential customers. And since, according to IDC, SB e-commerce has so far been weighted towards business-to-consumer transactions, cable’s close ties to consumers could have some advantages in the SB market space.

Cable operators are also uniquely positioned to include video as part of the service package they offer to SMBs. This could have particular appeal to health-care and other facilities with waiting rooms; restaurants, bars and hotels; offices wanting access to business-oriented TV services like Bloomberg Television; and schools and businesses interested in distance learning.

We get a sense of SMBs’ potential significance for cable when we consider the role of Cox Business Services (CBS) in its parent’s revenue mix. CBS is the Cox unit that serves businesses in a growing number of the company’s markets. According to a company spokersperson, current CBS revenues are roughly comparable to the residential revenues Cox generates in one of its metro markets. But while residential revenues are growing at only high single digit rates, CBS revenues are expected to nearly double from about $50 million in 1999 to $90-$100 million this year, with Cox expecting similar growth rates next year.

A similar view is suggested by another back-of-the envelope calculation. Industry experience thus far suggests the following rough rule of thumb: a single business is passed for every 20 homes passed by a typical cable network. At the same time, the typical monthly bill for cable modem service tends to be in the $80-$150 range for a small business versus $40 for a residence.

If, based on these cable modem billing trends, we assume that the average monthly revenue from the average SMB customer will be three times that of a residential customer, this suggests that SMBs already passed by cable networks represent a potential 15% boost in total revenue.

Given the greater potential for value-added services and multiple voice lines in the business market, this figure could prove conservative going forward, and even more so in terms of cash flow, since SMB margins tend to be higher than residential margins.

On top of this would be additional revenues from SMB-driven line extensions. For example, in one market where commercial cable modem service was launched in 1997, the local operator has since extended its network to reach an additional 20% of area businesses.

While all major cable operators have established some presence in the business market, their strategies vary considerably. We highlight some of these differences below.

Comcast is just beginning to mobilize a focused assault on the business market. In November company officials said they expected to invest $75-$100 million during the fourth quarter in a new unit called Comcast Business Communications (CBC), an amount they predicted would taper off to $25 mil. per quarter by yearend 2001. CBC’s initial market launch is slated for Baltimore during first quarter 2001, to be followed by other urban centers in Comcast’s northeastern "super-cluster" later in the year.

One factor driving Comcast’s CBC launch is its expectation that its core cable business will begin to generate substantial free cash flows as it winds down its network rebuild program over the next few years. According to Comcast president Brian Roberts, this expectation of accelerating free cash flow growth triggered "a search to identify discretionary business opportunities that allow us to generate 20-30% returns on equity." It apparently views CBC as one such opportunity.

Comcast’s Burke says CBC will be "focusing exclusively in [Comcast’s] footprint, to leverage our fiber, our brand and our people." Roberts adds that CBC will have an "in-market, on-net, state-of-the-art, purely data focus" with voice being a secondary "oh, by the way" offering. Initially voice will be circuit-switched, but its likely that Comcast will be relatively early in adopting IP-voice solutions, both for its commercial and residential customers.

Comcast’s CBC initiative echoes and expands the strategic thinking that drove several other MSOs to launch CLECs earlier in the decade. At that time the industry was just beginning to beef up its plant with fiber backbones, but had no real ability to deliver voice and high-speed data on its coaxial cable distribution network.

Examples of this earlier trend are Adelphia Business Solutions (formerly Hyperion Telecommunications), a majority-owned subsidiary of Adelphia Communications, and

Time Warner Telecom (TWT) which, in the wake of a 1999 IPO, is 48% owned by Time Warner. Both have their roots in a realization by their cable parents that the fiber backbones they were starting to build in the early 1990s could be leveraged to serve business customers as well.

Table 1: Comparing Attacks on the Business Market

Since then, both CLECs have expanded significantly beyond these roots, while pursuing somewhat different strategies (see Table 1). ABS has chosen to aggressively expand beyond the bounds of Adelphia’s cable footprint. At the end of the third quarter it was active in 79 markets, with a target of 200 markets by the end of 2001. In addition, it has acquired 195 LMDS licenses covering over 30% of the nation’s population, mainly in the eastern half of the country.

At the end of third quarter 2000, ABS served 576,857 access lines. Of these, 39% were on-network, 10% were Type II and 51% were off-network. Of the 83,225 new lines added during the quarter, 24% were on-network, 8% were Type II and 68% were off-network, a mix that suggests its marketing effort in newly-launched cities continues to outpace its network buildout.

Voice accounted for 81% of ABS’ $93.6 million in quarterly revenues, with the remainder coming from Internet, dedicated access and data services. Total revenue for the quarter was up 16.6% from the second quarter, with average revenue per access line at $50 per month and average lines per customer at 14. Capital spending for the quarter was $188 million, gross margins were 45.6% and EBITDA was a negative $25.2 million. Reciprocal compensation accounted for 13% of revenue vs. 10% in the prior quarter.

Though TWT operates as a totally separate company from its Time Warner parent, it has been slower than ABS to expand beyond the reach of its parent’s fiber networks--nearly all of TWT’s 22 currently active CLEC markets are also Time Warner Cable markets. But this is starting to change and will do so even more dramatically with TWT’s planned $690 million acquisition of GST Telecommunications. The GST deal will add 15 additional markets, most of them in western cities not served by Time Warner Cable.

Whereas ABS’ aggressive expansion and continued dependence on off-network services contributed to its negative EBITDA, TWT’s focus on higher margin on-network services sold to larger businesses—plus a $27.3 million boost from reciprocal compensation settlements--helped it generate $28.4 million in third quarter EBITDA on $121.2 million in revenue. During the quarter its gross margins were 60% and the relative shares of revenue generated by dedicated transport and switched services were 59% and 41%, respectively, compared to 57% and 43% in the third quarter of 1999. DS-0 equivalents were 9.81 million, up 23% from second quarter’s 7.98 million.

With its TWT offspring fully grown and operating as a separate entity and its parent walking down the aisle with AOL, Time Warner’s cable operation is once again giving birth to business-focused initiative. Sharing parenthood in this case is Road Runner, the high-speed data joint venture owned by Time Warner, AT&T, Microsoft, Compaq and Advance/Newhouse.

Unlike TWT, whose focus has been on fiber-fed services provided mainly to larger businesses, this new initiative aims to leverage the Time Warner/Road Runner HFC-based cable modem platform to deliver a suite of IP-based services to smaller businesses. Leading the charge in Time Warner’s SMB campaign is its operation in Portland, ME, where commercial and residential Road Runner service were launched in April 1997 and where an VoIP market trial began this past summer.

In Portland, the Time Warner network passes roughly 80,000 homes and businesses, with Road Runner penetration sitting around 22% of total passings as of October and tracking a few points higher for businesses than for homes.

Rick Preti, the first Road Runner employee in Portland, now heads a full-time staff of more than 34. In addition to broadband access, they provide a range of services, including web hosting, VPNs, telecommuting, e-commerce, security management, media streaming, managed bandwidth and network integration.

When Road Runner was launched in Portland, SMBs had virtually no alternatives to expensive T-1 lines or an ISDN service that charged $.02 per minute. By the end of 1997 the service had attracted 250-275 commercial customers, the majority of which had 5-15 employees. These were mostly professional offices, including graphic artists, ad agencies, media and law firms. By the end of 1998—which in Portland was still the pre-DSL era—Road Runner was closing in on 1,000 customers, including some larger enterprises seeking work-at-home solutions.

In late 1998 and early 1999 the company began to staff up to deliver the value-added services increasingly demanded by its commercial customers, whose ranks grew by about 900 in 1999. At the same time, it continued to selectively build out the HFC plant to reach more businesses. According to Preti, the company has been adding about 400-600 passings per year, and now reaches roughly 55% of Portland’s businesses versus 35% when the service launched in 1997.

With roughly 2,500 commercial accounts as of October 2000, Preti said hosting, integration, e-commerce and other services were approaching 25% of total revenue, a figure he believes will reach 35-40% in 2001. The company is also working with local developers to develop new content. An example of this is Road Router, an online mapping service developed with DeLorme, a Maine company specializing in GIS applications. Typically, say Preti, these deals involve no cash payment to the content partner, but rather a prominent placement on the Road Runner start page. That page, says Preti, receives roughly a million hits per month. Ad sales have also been brisk, he says.

According to Preti, commercial customers today account for roughly a third of total Road Runner revenue in Portland. If we assume that residential cable and Road Runner both have average monthly bills of $40 and penetration rates of 70% and 20% respectively, this would mean that Road Runner as a whole accounts for roughly 30% of total Time Warner revenue in Portland, with commercial accounts representing one-third of this, or about 10% of total revenue.

And there’s more on the way in Portland. This summer Time Warner began offering a VoIP service called Line Runner to 1,000 Portland customers. The service runs on a second-generation DOCSIS platform supplied by Broadband Access Systems and offers second-line residential service and business lines for $9.95 and $17.95, respectively, per month. A bundle of nine calling features is also available for $3.70 a month. Preti says the company will probably spend about a year in this trial phase before undertaking a broader commercial launch.

Nationwide, Road Runner’s commercial service is available in more than 20 markets, with a target of 40 set for first quarter 2001. Local staff are supported by a corporate team of 10 that helps in areas such as product and account management and marketing. The corporate staff also focuses on work-at-home deals that involve multiple Road Runner markets.

Cox Communications—which today delivers voice on a circuit-switched basis—has probably been the most active MSO in terms of serving businesses over its existing HFC network.

Though some areas with high concentrations of large office buildings have yet to be reached by cable’s HFC networks, these networks often do pass a large number of smaller commercial structures. Typically the latter have not attracted investments by fiber-based CLECs and may be eager for a facilities-based alternative to their ILEC. Table 1 supports this notion, showing Cox with 406 on-net buildings per market versus 113 for TWT and 40 for ABS.

At the end of this year Cox will be offering business customers a range of voice, video and data services in nine of its largest markets, six of which were launched in 1999. A tenth market introduced commercial data service in 2000, with another six expected to follow next year. By yearend 2001, CBS will be active in nearly all of Cox’s major markets.

At the end of the third quarter, Cox was delivering voice, video and/or data to SMBs in 4,061 on-network buildings up from 3,774 at mid year. It also claimed 4,000 SMBs as high-speed data customers and was delivering 956,027 voice-grade equivalent circuits, an increase of 12% during the quarter.

CBS’s 435 local market personnel are supported by a corporate staff that has grown from 10 to at least 50 during 2000. This corporate staff also leads a sales effort aimed at national accounts, including carriers, REITs, government, hotel chains and schools. In addition to its internal sales staff, Cox uses some agents, including VARs and installers of PBXs and LANs. Development of a national agency network is on its agenda for 2001.

To prepare for further expansion, Cox is deploying a next-generation commercial billing platform and using Siebel software to create a national prospect database. It is also

standardizing and scaling customer support processes to support acquisition of up to 30,000 accounts. This year it launched its first national image awareness campaign, with the tag line "Plug in. Do business."

Like other MSOs, Cox expects the introduction of DOCSIS 1.1 products next year to greatly improve its ability to support SLAs and Quality of Service requirements. Comments by company officials suggest that decisions regarding Cox’s role in the ASP market space and future VoIP deployments will be tied in large part to the process of proving out DOCSIS 1.1’s capabilities and stability.

Its worth noting that, even in the business market, Cox often leads with its historic strength--video. Of its commercial accounts, 60-80% purchase video service, while 10-20% purchase data and less than 10% are voice customers. Though Cox sees bundling as the wave of the future, the percentage of multi-service commercial accounts remains relatively low today, with video plus voice somewhat more popular than video and data bundles.

Table 2, based on an analysis done by Broadband Markets, presents a snapshot of the SMB population in several markets served or targeted by cable SMB initiatives: Portland and Baltimore (both mentioned in this article), four CBS markets, and Long Island, NY, where Cablevision Systems has been delivering commercial services through its Lightpath unit for a number of years.

The table examines the density of cable’s new target market (businesses) in relation to its existing customer base (housing units), breaking the former out by establishment size and type. It shows per-home concentrations of very small businesses (1-9 employees) substantially higher in Long Island (72 per thousand homes) and Portland (64 per thousand) than in the other five cities, which are all in the 39-49 per thousand range. Omaha, while ranking relatively low on this score, claims the highest density of total employees per housing unit.

In terms of their mix of business types, Long Island and Portland also stand out. Along with Baltimore, they have significantly higher proportions of retail and wholesale trade and health care than the other four cities. Omaha’s business population is the most heavily weighted toward information, finance and insurance, while Phoenix, followed by Hampton Roads, has the highest density of professional, technical and other services. Hampton Roads ranks highest in lodging and food service establishments.

Clearly, the race is on to bring broadband services to SMBs, city by city, building by building and vertical market by vertical market. Equally clear is the fact that cable operators intend to be players in this market space, which they view as a natural extension of their networks, skills, services and revenue base.