Cable's Next Big Thing

Verizon is running a radio ad in some markets featuring a man confronted by a stern police officer pounding on the door. The cop arrests the man for “paying your cable company too much for high-speed Internet access.” Such hyperbole is standard in the war between telcos and cable operators, but this particular ad has a twist. It isn't aimed at cable's core market, consumers. Instead, it's aimed at the owners of small businesses, who are increasingly being courted by cable operators with discount offers on nearly identical phone and data business.

Cable operators see small and medium-size businesses as their Next Big Market. With the push behind residential telephone services racing ahead, they are hungrily eyeing the $60 billion a year that these businesses spend on telephone and data services. By comparison, consumers spend around $95 billion a year on cable and satellite-TV services.

If executives can snag the 20%-30% of the market they're predicting, commercial services could be a source of financial growth.

“Clearly, there's a window of opportunity,” says Jan Woodcock, a principal in Deloitte Touche's media and telecom practice, which has prepared a major study on how cable operators should target the market. “The telcos are not truly focused on this market right now.” Instead, they are concentrating capital to launch consumer video and data services and devoting sales efforts to the huge companies that can each spend tens of millions of dollars on telecom services.

Target: small businesses

Cable operators generally avoid the large-business, or “enterprise,” market. Those customers—from regional banks to giant corporations—have complicated demands and locations in multiple cities. They spend heavily and might have possibly four or five companies courting them and cutting prices to get their business.

The small and medium-size commercial players—generally defined as companies requiring fewer than 50 lines—have generally had only their local Bell company for service.

“If you are a small or medium-size business, you may not have seen anybody from Verizon or SBC for years,” Comcast President Steve Burke said at Goldman Sachs' recent Communicopia investor conference. “It's very hard to get competitive pricing; it's very hard to get anybody's attention.”

Notes Credit Suisse cable analyst Bryan Kraft, “The smaller you stay, the higher the cash-flow margins.” He estimates commercial-services profitability at 35%-45%, around the same as cable's high-speed Internet and residential phone service.

Telcos generally charge small businesses double what they charge residential customers, Kraft adds, so cable operators have a lot of room to undercut the competition.

“We think we can cut the rate in half that business customers are currently paying and still get excellent returns to our capital,” says Cable­vision Systems COO Tom Rutledge.

The business market has largely been beyond cable systems' reach. Businesses are not big buyers of video services, and until the mid 1990s, operators had little else to sell. Hence, operators didn't even connect to commercial buildings, generally ignoring central business districts or suburban office parks.

A consortium of operators took a stab at a big commercial push in 1992 by acquiring Teleport Communications Group, the first of the “CLECs,” or competitive local exchange carriers, which built phone networks only to large businesses, cherry-picking the best customers of traditional phone companies. The operators exited before the 2000 telecom crash, making huge profits by selling Teleport to AT&T for $12.2 billion.

No edge for cable

Operators Time Warner, Adelphia, Cable­vision and Cox also started their own CLECs. But such ventures require their own separate—and expensive—fiber networks. Cable operators have no particular advantage in that game.

The new commercial services are intended to run over the same wires serving homes, creating yet another revenue stream out of capital already deployed and paid for by residential services. That amplifies the most important measure: return on invested capital.

Cox Communications CFO John Dyer estimates that, within one year, the company will generate nearly 70¢ in revenue from every $1 in capital invested in commercial telephone service. “I don't think it's any more or less complex than a residential offering,” he says.

Just as Cox was the first cable operator to launch residential telephone, the company is the leader in commercial services. The company expects to generate $500 million in sales this year, around 6% of its total revenue.

Time Warner and Cablevision are also making a major push. Comcast—late to the residential phone game—expects to make a heavier push in 2007 and 2008. However, Comcast poached the head of its own commercial-services unit, Bill Stemper, from Cox Business.

Cable operators will need a new product to sustain growth. Operators were fortunate that consumers' appetite for high-speed data service exploded, taking up the slack as basic-cable revenue faded. Residential telephone revenues are surging but will slow once penetration maxes out.

Video-on-demand failed to be the big cash machine that operators once envisioned. Fees charged for digital video recorders offer only a small boost. Other hoped-for moneymakers—such as interactive games, home networking and home security—offer only minor financial contributions at best.

Kraft is cautious about assessing how big a kick commercial services will provide. He estimates that commercial services will boost the revenues at Comcast—currently a $29 billion company—by about one percentage point a year. Nice, but not enough to offset the expected revenue slowdown in video and data. “I'm not ready to get real aggressive,” he says, “until I hear more about their plans.”

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