Turnkey Proves Costly For Cable System ISPs

With ISP Channel telling its high-speed cable affiliates it is leaving the cable-modem business for good no later than the end of this year, the so-called "turnkey" business model for cable ISPs has just about gone the way of the dodo.

Of course, ISP Channel wasn't the first company to realize that turnkey contracts with affiliates, especially those with small subscriber bases, don't make business sense, as expenses pile up and the horizon of profitability recedes into the future.

Some companies that played in that sandbox have gone under, such as BTG Inc. subsidiary Community Networks Inc., which waved goodbye in March of 1998. Another, Webb Interactive Services Inc. (formerly Online System Services Inc.), changed course completely, shedding its turnkey, cable-ISP bent for a model that centers strictly on building broadband content.

Another, High Speed Access Corp., has moved towards a network-services model, attempting to leave the turnkey approach in its rear view mirror forever.

The turnkey approach looked like a winner in the early days, as companies like ISP Channel and HSA snapped up contracts with independent cable operators and smaller MSOs. Their footprints continued to grow.

At the same time, cable operators, accustomed to getting 50 percent of the revenue under those contracts, seemed to adore it. Life was good. Stock prices were high.

Need somebody to provide connectivity to your cable modem customers? We can help you. Need customizable bill-stuffers, newspaper ads and other marketing tactics to drive customer acquisition? Look no further. We're turnkey. We'll do it all.

That landscape turned darker for this new breed of turnkey cable ISPs after the model started taking on communistic proportions. It looked as pretty as a petunia on paper, but, in practice, morphed into patches of ugly crabgrass.

Webb Interactive Services saw those potential ramifications early on.

"When HSA and SoftNet entered the independent high-speed access arena, we changed our model to compete with them," company chief financial officer Bill Cullen explained. "We shifted our model to the same turnkey approach."

Like its competitors, Webb Interactive's pitch to cable operators was that it would obtain the equipment, install it, load in all of the necessary software and provide what other assistance was required to market the services.

That idea didn't last long-especially after Webb Interactive's bean counters figured out how quickly those expenses would pile up.

"We didn't have the capitalization to sustain that business for the length of time it would require to become profitable. And we didn't have the same capital structure as an HSA," Cullen said, referring to the millions of dollars Paul Allen's Vulcan Ventures Inc. had pumped into Webb Interactive's former rival.

Webb Interactive made the decision to get out in late 1998, early 1999, even as it was pursuing a contract with TCA Cable TV Inc., which was absorbed by Cox Communications Inc. in 1999 for about $4 billion in cash and stock.

"We took a look at our capabilities and our capitalization and decided to do the content side of the turnkey business," Cullen said, noting the emergence of another heavy hitter in December 1998: @Home Solutions, an Excite@Home Corp. division that targets smaller cable markets.

At the time, Cullen's company had fewer than 10,000 paying high-speed access customers, most coming from deals with mid- to small-sized MSOs such as Peak Cablevision (sold to Cox), Bresnan Communications (sold to Charter Communications Inc.) and InterMedia Partners (partitioned by AT&T Broadband and Charter).

"We found our core capability was more in the area of content-development products, which translates into communications tools and local content provisioning, which are less capital-intensive," Cullen said. Today, Webb Interactive has companies such as Bell ActiMedia, Corel Corp. and RE/MAX International Inc. on its customer roster.

"Cable is the ideal small-business content aggregator," Cullen added. "We still have an eye on cable, but have not developed a specific product for that market. We're putting some finishing touches on those proposals."

Though HSA had financial and deployment help from Vulcan and Charter, it also concluded that the turnkey model wasn't financially viable. Instead of focusing on content, HSA-which has the green light to speak to ISP Channel affiliates about inking new contracts-completely changed its approach about a year ago.

"From an ISP standpoint, the full turnkey agreement ensures the ISP is incurring all the risks," HSA CEO Dan O'Brien explained, referring to the capital costs associated with customer acquisition and connectivity.

Those costs vary dramatically between major markets and small markets, and a 50-50 split doesn't offset the costs handled by a turnkey cable ISP, O'Brien said. "That's just not an appropriate skew in today's world based upon risk and reward."

The return on investment for connectivity costs is much lower in rural areas than it is in large cities, O'Brien said. "The reality is T-1 costs will be the highest costs when you link a cable headend back to the Internet. What could be hundreds of dollars in an urban market could be thousands of dollars in a remote one."

Dan Donnelly, @Home Solutions' vice president for affiliate operations, agreed. "It all boils down to the circuit costs," he said.

His company thought about using the turnkey approach at first. "The farther away customers are from our PoP (point-of-presence), the more costly it becomes" for the cable ISP, he said.

While that puts a financial strain on ISPs serving small cities, those costs are much easier to swallow when the city in question has tens of thousands of potential customers.

Donnelly said some areas served by @Home are 3,000 miles from the PoP, but the company can afford the circuit costs because those cities are extremely large and scalable.

Which raises another reason for the downfall of ISP Channel, which found it difficult to achieve scale after the business landscape changed in 1999, and large, cable conglomerates continued to snap up independent cable operators and smaller MSOs.

O'Brien said HSA, with help from corporate cousin Charter, has been able to create the scale that ISP Channel couldn't achieve. Nonetheless, the company concluded that turnkey would have to make way for a more equitable network-services model, which is broken down into Tier-1, Tier-2 and/or Tier-3 support.

In that scenario, HSA in some circumstances won't get dinged for connectivity or customer acquisition costs.

Instead, the cable operator handles those costs. In turn, HSA gets a fixed fee per subscriber instead of a revenue split, O'Brien said. HSA won't look back. "HSA has made it clear it won't renew under the same [turnkey] terms," O'Brien said.

The network services model is also designed with flexibility in mind.

For example, HSA reworked its contract with Charter, providing Tier-2 and Tier-3 support to the MSO. But Insight Communications Co. in Columbus, Ohio, tapped Road Runner for Tier 2 and Tier 3 and uses HSA for Tier-1 elements.

Another MSO partner has approached HSA about renegotiating its original turnkey contract to a more flexible network-services model. O'Brien declined to name that MSO.

A move away from turnkey also gives operators more flexibility in how they market and bundle high-speed services, O'Brien said.

"We believe operators need an environment where they maintain the relationship with the customer. If we're billing for the data service and the operator is billing for the video, how do they bundle them together?" he asked, noting that cable operators can then maintain ties with customers by allowing use of the operator's name on the cable-modem service and electronic-mail domain.

Though a network-services model could help companies like HSA survive well into the future, cable ISPs as a whole are also trying to expand their portfolio by helping cable operators tap the extremely lucrative business market.

Earlier this year, Road Runner launched "Road Runner Businesses Class," offering a suite of electronic-business features such as Web hosting and merchant services to commercial customers ranging from small-office/home- office single users to small businesses and larger corporations.

Excite@Home's @Work division is doing something along those same lines, dabbling in digital subscriber line services and providing dedicated Internet access, private networking and Web-hosting services.

HSA offers DSL in five cities-Denver; Tampa; Atlanta; Raleigh/Durham, N.C., and San Antonio-with 24 sets to come online by the end of 2001. It also offers Web-services-management services through NetPerformance, a Web hosting-firm it acquired earlier this year.

"When a business calls you and they ask for high-speed Internet access, that's really the beginning of the relationship, not the end," O'Brien said. "Ultimately, if you want to develop a long-term relationship, you have to sell them more than just access."

That credo extends beyond the commercial sector. In residential markets, high-speed connections typically only enhance narrowband experiences. As video-on-demand and video streaming enter the picture, people will likely want to sign up for the additional, media-rich content for their televisions and computers.

For instance, British Sky Broadcasting Group plc builds incremental revenue by offering viewers the ability to change camera angles of soccer matches and to look up statistics on the Web as they're watching the game on the pitch.

Of course, HSA, Road Runner and Excite@Home aren't known as content aggregators, and look to others to provide better broadband content and applications.

For example Road Runner is offering voice communications over the Internet through a partnership with Lipstream and has signed on such Internet studios as Gotham Broadband to design content specifically for the high-speed sphere.

Excite@Home struck a deal with The MTVi Group for music news and music-video clips, and offers broadband game demos and trailers through an agreement with Gigex Inc.

HSA will leverage its relationship with Vulcan Ventures' Digeo Broadband Inc. unit, which is building an integrated TV and PC portal for Charter, and later, it hopes, for more MSOs.

The successful companies will not be completely dependent on access revenues alone," O'Brien said. "They will find reasons to incent customers for more than just speed."