September 13, 2009

Digital Highways: The Role of Government in 21st-century Broadband Infrastructure

Broadband’s importance to national economies prompts governments to support the deployment of nationwide networks.

Next-generation broadband networks promise much faster transfer of information and services, promoting overall national productivity and prosperity. For that reason, public policymakers are stimulating or even making significant investments to establish such networks. Yet there are significant hurdles to deploying next-generation broadband. Private investment in the sector will lag until there is greater certainty over revenue, regulation, and technology. Government policymakers, who are in the best position to create an environment that is conducive to broadband networks’ development, are the ones who must overcome these hurdles.

World leaders who have committed to building next-generation national broadband networks (NGNBNs) compare them to other infrastructure, such as roads and airports, in terms of their importance to economic growth. Nations that don’t make this commitment risk getting dominated by those that do, as countries that communicate and share information boost their economy and future prosperity “The job of building the next generation of broadband networks is too important to be left at the mercy of investors’ willingness to enter an uncertain market,” explained Sabbagh, the partner leading the global Communication, Media, and Technology practice at Booz & Company. 

What Next-generation Broadband Could Deliver

Broadband has transformed the ways in which businesses, consumers, and governments function. For businesses, broadband has enhanced labor productivity, enabled innovation, and supported the creation of a new generation of entrepreneurs and business models. For consumers, broadband has increased access to information and provided links to knowledge, social networks, and communal inclusion. For governments, it has enhanced opportunities for public health and education, enabled more efficient public services, and boosted economic growth.

“Our analysis shows that 10 percent higher broadband penetration in a specific year correlates to 1.5 percent greater labor productivity growth over the following five years. Countries in the top tier of broadband penetration have also exhibited 2 percent higher GDP growth than countries in the bottom tier of broadband penetration,” said Bahjat El-Darwiche, a Communication, Media, and Technology principal at Booz & Company.

But all broadband networks are not created equal. Customers are now seeking much more from broadband services, such as virtual worlds and communities, or productivity-enhancing applications such as cloud computing and telepresence. Such applications require more capacity and capability than first-generation broadband can offer. Next-generation networks would enable access speeds up to 30 times higher than current networks, but would cost 10 times as much per subscriber to deploy.

The Uncertainty Hampering NGNBN Growth

Many policymakers believe that NGNBNs are worth the price. Investors, however, are uncertain of their returns, and thus nationwide deployment of next-generation networks is still very limited. “Although the technologies have matured, very few countries have yet been able to drive the adoption of a next-generation national network,” commented El-Darwiche.

Deployment of NGNBNs is highly risky for operators. It is an open field of competition, where the rules are unclear, the risks unknown, and the payback uncertain. Investments in NGNBNs are front-loaded and also irreversible, which is holding investors back until they understand the business model and the extent of the risks. Operators are asking three important questions.

How much will this really cost? A nationwide NGNBN may represent the single largest infrastructure investment ever made by a telecom operator: The cost of deploying a NGNBN in major markets may be up to 10 times the EBITDA of an operator’s national business. Although operators may still be considering tactical urban deployments of next-generation networks, they are reluctant to consider nationwide deployments, particularly in light of the current economic crisis. Furthermore, even if the economy and credit market were settled, the technology isn’t: Competing wire-line technologies have investors reluctant to place significant bets on just one.

How will we capture revenue from the network? Operators’ reluctance to spend on a new network stems from the fact that they will pay to build it, while competitors who don’t have to make that investment can capitalize on it. Telecom operators face competition from players in adjacent industries, including cable, and from application providers like Skype. Increased competition and new business models are fragmenting revenue streams, reducing the amount that network operators can capture. “This disrupts the traditional revenue model of telecom, whereby an operator would invest significantly to build the infrastructure and draw value from its networks over a period of 15 years or more,” said Sabbagh.

Additionally, consumers are accustomed to inexpensive, bundled, flat rates to make voice calls and consume data, while applications such as YouTube, Facebook, and Google have consumers expecting online services to be either free or cheap. This makes it difficult for NGNBN operators to convince customers to increase their telecom spending.

How will the networks be regulated? Whether NGNBNs can generate returns depends on the governing regulatory regime. However, in most countries, these are still being defined. Government regulatory tools for first-generation broadband, including local loop unbundling and interconnect regimes, may not apply to NGNBNs.

“Regulators are attempting to define a new regulatory regime for NGNBNs for a smooth transition from the current regulatory base, while protecting the investment of alternate operators in first-generation broadband networks,” stated El-Darwiche. Operators are uncertain of their ability to monetize their investments in NGNBNs, which is dissuading other investments. Market forces alone can’t resolve these regulatory issues, and policymakers may need to proactively address them.

Choosing the Right Approach to Government Involvement

To date, government response to the market’s need for NGNBNs has taken three distinct forms: Some policymakers have chosen to drive the process actively (driver governments), some have chosen to facilitate private-market solutions (facilitator governments), and some have chosen to step back and observe market challenges and jump in only when absolutely required (observer governments). If the goal is to deploy NGNBNs as quickly as possible, driving the process is the best option. Nations with “driver” policies have much higher penetration rates.

Governments taking this active approach have three levers for building out NGNBNs. First, they can encourage the creation of new business models that would push the industry to move from its current vertically integrated approach to more risk-efficient multilayer models. Second, they can invest directly in building networks through direct ownership, public–private partnerships (PPPs), or concessions. Finally, governments can choose to stimulate NGNBN service demand through end-user subsidies or training programs.

These levers are not linear nor mutually exclusive: Governments can choose to employ one or all of them. The choice depends on the government’s objective in deploying a NGNBN and the market obstacles that it must overcome. Two factors determine the best option for governments to accelerate NGNBN deployment: The expected coverage if driven solely by market forces; and the proportion of the population that would be able to afford next-generation services offered by the market, without government involvement.

“The ideal is universal coverage with uniformly affordable access. Once governments have assessed where their networks fall short and what levels of coverage and affordability they are prepared to accept, they can determine which levers will work best,” Sabbagh commented.

1. Introduce new business models: Traditionally, telecom has been a vertically integrated sector, with operators owning and operating all elements of the network while serving end users. This vertical integration is inhibiting investments in NGNBNs, with operators wary of incurring deployment costs and then sharing the infrastructure. Governments can solve the problem by introducing multilayer models, consisting of up to three different entities: a PassiveCo, an ActiveCo, and a ServiceCo. 

PassiveCo operations are the most capital-intensive, but also face the least competition, allowing for low-risk, utility-like returns. By contrast, ActiveCo and ServiceCo entities operate in highly competitive industries, with higher returns but also higher risks. “Restructuring the industry with new entities would enable the government to distribute NGNBN investment risks across several players, assign payback expectations tied more closely to risk, and enable wider and more affordable coverage,” El-Darwiche said.

Introducing new business models is the most appropriate approach when the government expects a market-driven solution to be affordable for only a limited percentage of the population. These new business models would alter market dynamics, thereby increasing the coverage and affordability of a NGNBN. Governments need to approach stakeholders to highlight the benefits of the new model and enable the market to meet the investment demands of the next-generation broadband network opportunity on its own.

2. Invest in network infrastructure: Direct government investment in NGNBN infrastructure reduces the magnitude of investment required from the private sector and accelerates NGNBN deployments. Government investment comes with inherent risks, including the potential to dissuade private-sector investments. A robust risk/benefit analysis is imperative. In making their investment, policymakers have to consider three distinct options: direct ownership, public–private partnerships (PPPs), or concessions.

Government investment in network infrastructure is best suited to situations in which the market will deliver an NGNBN that is affordable but has limited coverage, as government investments can ensure nationwide availability. After deciding an investment is warranted, governments must next decide which investment to pursue. If existing or potential coverage would require a substantial government investment, it may be best to own the infrastructure directly. However, if there is a reasonable deployment of NGNBN infrastructure already, a PPP or concessions model may be more suitable.

3. Stimulate demand: Many consumers are unaware of the life-changing applications next-generation broadband can bring them. Governments can address this by offering public services through next-generation networks, whetting demand for other services, providing some assurance to network operators that revenue will follow. “This lever is supplemental to introducing new business models and investing in infrastructure. Demand stimulation is appropriate in a scenario in which there is widespread coverage but services are not widely affordable or uptake has been limited,” stated Sabbagh.

Getting Up to Speed

There are three key elements that governments considering deployment of an NGNBN must consider. It is vital they get a strong grounding in the needs of their markets, the likelihood of private-market success on its own, and what the market requires from the public sector—whether regulatory definition, funding, or some other critical action. Second, they have to be willing to engage in dialogue with stakeholders to address their concerns and ensure their cooperation. Finally, they must set clear goals for themselves on the kind of reach they are hoping to achieve, and at what levels of affordability—and then design the policy.

Next-generation broadband should be part of an economic strategy, rather than a concern for sector regulators. In today’s global economy, access to information is crucial. For mature economies, the twin imperatives of the digital economy are speed and access, and next-generation broadband has the potential to offer both at levels never before imagined. Countries taking the first step towards next-generation broadband will be better off than those that remain on the sidelines.