Government failure as a Broadband Service Provider

The empirical evidence shows that the public provision of private goods, such as broadband services, often leads to: unprofitable operations that push the recovery of losses to taxpayers and to other public services; and barriers to entry which displace and crowd out private investment. The result is anticompetitive and it raises consumer costs. Evidence shows that government-run networks are exactly what policymakers and regulators should want to avoid, if encouraging private broadband investment and improving consumer welfare are policy goals.

Municipal Networks lack the incentives to maximize consumer satisfaction, while minimizing costs. Unlike private firms, managers of government-run enterprises often seek to maximize their workforce and spend their budgets and they are prone to create subsidized pricing and shift costs to other services.

Whereas market inefficiencies are normally challenged with competitive rivalry and disciplined by market entry, because governments seldom go out of business and because their enterprises can sustain losses by pushing these costs to taxpayers or garnering subsidies from other government services, municipal-owned network services provide a formidable barrier to competitive entry. As a result, municipal-owned broadband services can exhibit gross inefficiencies, poor quality of service and slow speeds, while putting the public on the hook to cover the cost of failures. On the other hand, private markets do not have these disadvantages, and the public is not obligated to pay for its failures.

In smaller (secondary) municipal markets, these problems become even more magnified and harmful for consumers, since these markets can sustain so few competitors. In these cases, municipal-run services become monopolies, thereby completely locking out private investment and competition. These municipal businesses can produce the same outcomes as monopolies – higher prices and lower output – exactly what policymakers and regulators should want to avoid and exactly what the spirit of the Telecommunications Act of 1996 attempted to remedy. In fact, the mere threat of entry by municipal broadband service providers is sufficient to deter private investment into these secondary markets.

Public provision of private goods, such as broadband services, tend to: lose money; push costs to other public services and to taxpayers in the form of taxes and implicit subsidies; and eliminate competition by displacing and crowding out private investment. In their book, Professors Bennett and Johnson reviewed numerous studies that compared the performance of services that were governmentally and privately produced, including refuse collection, fire protection, debt collection, ship repair, electricity services, airline services, ambulatory care, and other services. Their analysis found that government production was far more costly than private production. They also found that government financial data often excluded comparable costs (such as net interest, pensions, taxes, and other opportunity costs) that, when included, made government production twice as costly as private production.

Works by these and other economists supported the subsequent deregulation and privatization that has swept much of the globe. There is ample evidence that industry deregulation, particularly in airlines, trucking, railroads, long distance telecommunications and brokerage services, led to falling consumer prices, increases in market efficiency, the development of intermodal competition, growing consumer demand, and large increases in consumer welfare benefits – collectively equaling over $100 billion per year. Like these examples of higher cost and inefficiency, government production and provision of communications services exhibits dismal performance that is anticompetitive and reduces consumer welfare.

As several municipality-owned electric utilities began offering broadband and other network services, there were several studies that investigated the financial performance of these early projects. One report summarized these studies and provided a financial assessment of each of these government ventures and showed all the municipal electric utilities’ telecommunications ventures proved unprofitable, averaging $770 in losses per subscriber. It is very likely that these estimates are conservative, since these companies often receive preferential access to rights-of-way, as well reduced costs from the use of public property and capital. In addition, as previously noted, some costs are not always included in the income statements of government enterprises, making them difficult to compare with private enterprises.

Overall, municipality-owned electric utilities are failures from the beginning. In some cases, these broadband ventures were subsequently sold and some ventures continued with the help of subsidies tacked onto consumers’ electricity bills. The losses from these examples show that municipal-owned production of broadband services is a bad public policy, including:

  • Quincy, Florida spent $3.3 million on a municipal network, NetQuincy, and it never obtained a positive return on its investment. In 2005, its revenues were $415,000 and costs were $930,000 – like Bennett and Johnson’s book concluded – at twice the cost. The network eventually went out of business.
  • In total, Groton City, Connecticut borrowed $34.5 million for Thames Valley Communications. After losing money in every year it operated, the company was sold for $550,000 in February 2013. Groton Utilities is assumed $27.5 million debt of its subsidiary. Also, Moody’s has reduced Groton City’s bond rating twice.
  • Provo, Utah, sold its government-owned network, iProvo, for one dollar after spending $39 million to build it. It never made a profit and it cost the city an estimated $1.7 million to hand over the company.
  • Orlando experimented with a public Wi-Fi system in 2005. The network was designed to serve a mere 200 users, but the city couldn’t even meet that very low target. Over the 17 months the network was operational, an average of 27 people used the service each day.
  • In 2005, Philadelphia’s Wi-Fi system promised citywide Internet services, but that eventually not was not be the case, as subscriptions fell short of projections and now serves only the municipal government.
  • Failing in 2012, Wireless Hollywood in Florida never worked and blocked other wireless Internet devices from working.
  • FiberNet was an Internet service provider built by the city of Marietta, Georgia in 1996. In 2004, the city sold FiberNet for $11.2 million, a fraction of the $35 million spent to build and maintain it.

There are many more examples of municipal broadband failures. Because many municipal broadband providers are not in good financial footing, cities sometimes fund the resulting revenue shortfalls by raising taxes or by increasing prices for other municipal services, like electricity, sewer and water. For the municipality, this advantage represents a barrier to entry that competitors, who do not pose these public risks, cannot tap into for funding. Moreover, these taxes and subsidies demonstrate that broadband prices are higher than advertised to the public, because they can be used to prop up failing municipal broadband services.

Going back to an earlier example demonstrates this risk. The Ashland Fiber Network (AFN) in Ashland, Oregon was launched in the late 1990s and accumulated debt of $15.5 million because of higher than expected construction and operation costs. Originally, AFN borrowed its startup funds from the Ashland Electric Utility. After several years of city departments covering AFN shortfalls, in August 2004 the city took out $15.5 million in bonds with an annual debt payment of $1.43 million. From 2005 to 2007 AFN did not contribute anything to its debt payment. In January 2005, Ashland City Council voted to give a $1 million subsidy to AFN — $540,000 from the wastewater fund and $460,000 from the electric fund. In October 2005, the city of Ashland adopted a surcharge of $7.50 on all electric bills to subsidize AFN, which was rescinded after protests from citizens. In December 2005, $500,000 was given from the electric department to help AFN pay off its debt. Property taxes now cover part of AFN’s debt.

If the private sector did this, it would be considered fraud or crony capitalism, but for municipal broadband service providers, it’s business as usual.

And, there are other examples of the same. In 2002, the eleven cities joined the Utah Telecommunications Open Infrastructure Agency (UTOPIA) by undertaking a $135 million bond. In August 2012, an audit report to the Utah Legislature revealed UTOPIA as never having a profitable year. UTOPIA lost $18.8 million in a recent fiscal year; had a negative net value of $120 million; and owed interest totaling $500 million until 2040. That is not all, in fiscal year 2013, residents of the eleven UTOPIA cities were scheduled to pay nearly $13 million for debt services.

For Burlington Telecom, the primary issue is the system’s debt load. A state audit by a Blue Ribbon Committee found the government-owned network had violated its state license for the five years it had been operational, and that it had no feasible way to repay its debts. The system’s debt totaled $51 million. Another issue with Burlington is that $17 million of its $51 million debt was illegally borrowed from taxpayers. Burlington’s massive burden and poor financial performance resulting in the city’s bond rating being lowered three times in just two years and was only one step above junk bond status. In its response to Moody’s, the ratings service, Burlington acknowledged: “The most troubling finding of the FY11 audit was that the City has very limited liquidity. The Burlington Telecom situation is by far the largest driver of this situation…”

In 2007, the cities of Mooresville and Davidson took over the former Adelphia Communications cable company, preempting a private offer from Time Warner Communications. Local officials believed that it was nearly a risk-free investment and Davidson’s Town Manager Leamon Brice declared “The potential growth of customers, and therefore profits is astronomical.” However, by 2010, the municipal broadband system (MI-Connection) had still not turned a profit. Revenues increased by just 3 percent in the fiscal year ending June 30, 2010, when they were projected to increase by 20 percent; and losses were $ 5.7 million down from $6.8 million the previous year. Also, for a second year in a row, MI-Connection had received a warning letter from state officials concerning its financial conditions and outlook. The two towns must either repay the systems debt with general funds or default. Davidson’s Town Manager stated the consequences of default: “That would have severe repercussions. First, the two towns wouldn’t be able to borrow again, and second a default would affect bond ratings and interest rates for not only our towns, but for towns across North Carolina and the nation.”

For Wilson, there apparently is a lot of money to be lost in providing broadband services to consumers, and they just want their fair share of it. The fact is that Wilson’s marketplace performance raises questions that should concern policymakers and regulators. As the Carolina Journal noted, when Wilson it began losing money on its broadband services, it began shifting those costs to its electricity customers: “According to its financial statements, Wilson has taken more than $11 million from its electric and gas funds to subsidize its competitive into the cable business. No wonder Wilson’s electric rates are 50 percent higher than that of Progress Energy and its natural gas rates are 30 percent more than PSNC Energy rates.”

To summarize, there are numerous examples of inefficient operations by municipal broadband providers who then push their losses onto the consumers of other municipal services and/or to taxpayers. This fiscal malpractice harms consumers.

In conclusion, municipal broadband networks crowd out private investment. As my review of municipal ventures shows, once a municipal-owned network provider enters a market, they can lose money and still survive by pushing financial losses to other municipal services and to taxpayers. Municipal broadband providers lose money and shift costs. This means that the effective price paid by consumers is much higher than advertised. Because broadband services are relatively price elastic, increases in cost can result in repressed demand. The combination of higher prices and lower demand means that municipal-run broadband network produce lower consumer welfare than their private counterparts. For these reasons, municipal-own networks are anti-consumer.

Creating government run enterprises is exactly what regulators and policymakers should want to avoid, if improving consumers welfare is the goal. Instead, public policies need to encourage private investments, if broadband is to be fully deployed and consumers are to fully benefit.

This op-ed was adapted from an ACI filing with the FCC. To read the entire piece and full citations, click on the FCC website.

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