If You're Thinking Big, Think Fiber

Entrepeneurs building big ISP businesses have all but written off dialup as a province of telcos and are more excited about cheap fiber and wave technology than modem farms because the former offer freedom from the telco death grip.

by Max Smetannikov [May 24, 2002]

ISPs developing their networks and services today look nothing like companies executing on business plans written in the 1990s. Simply put, the quintessential ISP of 1990s was EarthLink. The only kind of an ISP that makes sense launching today is Cogent.

For some of the executives who started out in this business with three DS-1 lines in their basement, the latest turn of events constitutes the second dramatic turnaround of telecom fortunes. Humble business ideas that captivated the world's attention in the early 1990s have been relegated to the back burner of technological progress as the dream of building telco-independent data networks becomes a reality for some service providers.

The big sea change in the ISP economics has to do with the evolution of overall costs of networking and competition.

"If you want to be a big ISP today you can't compete by buying traditional leased lines that lack the fiber's benefit of increasing DWDM capacity, you don't get the benefit of cost drops as the technology improves; and if you are too good you are beginning to compete with incumbent ISP—and you are at their mercy," said David Diaz, former chief technology officer of NetRail and a senior industry consultant.

But what about the titans of ISP industry that have built out their operations entirely by using the telco structure? EarthLink is still going strong in the wake of AOL, and United Online's claims for the number three spot on the ISP totem pole suddenly look legitimate now that the company went cash flow positive.

These are the companies that managed to use Internet hypergrowth and Wall Street fascination with IP technology to build out networks that are largely paid for but that cannot be copied in today's market conditions. The growth of Internet users has stabilized, industry insiders say, and building new dialup businesses would mean finding a way to snatch users from existing ISPs, not service Internet newbies.

"I don't think ISPs should dabble with dialup users anymore," said Diaz. "It is a lot of work, a lot of headache, and people like AOL and AT&T do it just fine. The whole point of dialup is to convert these users to DSL. You have to be on the scale of EarthLink or AOL to make money off dialup."

EarthLink executives feel that their initial strategy of building up a service company that happened to use dialup as the main technology of putting users online has succeeded in keeping competitors at bay and positioning the company to expand into new technologies. That said, the door for new entrants into any business other than national wholesale dialup is wide open.

"It's like anything, like why does a new restaurant open on the block that already has a Wal-Mart," said Steve Dougherty, EarthLink director of systems vendor management. "ISPs are a mature market, so you got to have something— a business model, a technology—to distinguish yourself."

That said, EarthLink itself would look into anything to get its users online. While its broadband and wireless efforts have been widely publicized, Dougherty said he never really stops looking for new types of access since EarthLink's ultimate goal is to provide Internet access to its users in all possible shapes and forms. Right now the company is investigating Wi-Fi and IP-over-electric wires technologies for future service offerings.

It is understandable that established ISPs like EarthLink have to stay on the leading edge of their business because they were almost upstaged by free ISPs two years ago as those companies rode investor optimism to try and use online advertising to pay for dialup access. While free access has gone the way of the new economy, one ISP have survived the demise of free service—United Online, created out of the merger of two biggest competitors—NetZero and Juno.

While United Online has a long distance to cover to catch up to EarthLink's billion-a-year revenue, it's a company to watch as it broke cash flow positive this month during arguably the worst year for telecom, online, and advertising industries—by converting some of its 20 million free subscribers into paying customers. Whatever advertising dollars will come United Online's way once the ad market recovers will go straight into profit.

Probably the last large scale ISP born out of the boom era, United Online boasts a better cost structure than EarthLink.

"Companies like EarthLink spend $150 million on capex per annum, we spend $2 million," said Mark Goldstone, United Online president and chief executive.

United Online hasn't reinvented a bicycle to achieve these savings, but rather implemented the same business model that EarthLink had—three years later. Through Goldstone's eyes, EarthLink appears to be a mini-telco, having to manage its own banks of modems after integrating all of its acquisitions. United Online, in contrast, is riding the wave of dropping prices in the telco world by getting progressively deeper discounts on wholesale dialup and bandwidth.

Low infrastructure expenses is the chief reason why United Online is profitable, according to Goldstone. And the best way to build an ISP with low infrastructure expenses today is to buy valuable fiber assets for a fraction of the price, say insiders like Diaz.

"Either ISPs need to acquire their own fiber or work with a few cutting edge networks that are lighting the fiber with DWDM switches and passing along the long term benefits," he said.

Which is exactly what Cogent Communications has been doing for the past 18 months. The company, which started out as a metro services provider along with now bankrupt Yipes, has been on the buying spree. It bought the backbones of PSINet and NetRail, and access rights from Allied Riser, a once high flying Building Local Exchange Carrier.

The back of the napkin business plan looks brilliantly simple. With Cisco as a backer, Cogent has a chance to get the latest fiber-optic equipment without piling up high yield debt. It needs these boxes to light its own network. A once hot commodity, dark fiber can be obtained in 21 markets where the service provider operates for only marginally more than leasing OC-48 pipes from telcos. Once the network is up, interconnection bandwidth bills could be cut by buying peering contracts and eyeballs that would provided traffic levels needed to sustain them. The company bought peering contracts through backbones, and has enough eyeballs through ARC buildings to satisfy its traffic requirements with partners.

These four pieces coming together make for a heady brew of building an ISP that is truly reliant on its own network, and has enough bandwidth to build out any service package an end user wants—be it a telephone service or a videoconferencing bridge.

That said, Cogent's service today is very simple: $1,000 a month for 100 Megs to end users, and $3,000 a month for the same bandwidth to resellers. Sure, an average business pushes 2 Megs of traffic out today. But Cogent executives are sure that offering Ethernet-size pipes would prompt companies using Cogent to start rethinking their distinctions between wide area and local area networks.

"Today most businesses use 100 Megs to connect to their file server on their LAN, and our model is literally to extend the LAN over the Internet," said Dave Schaeffer, Cogent president and chief executive.

Cogent will never lease a line from a telco, and has no plans to grow beyond the 21 markets it has connected with three OC-192 pipes—which is more bandwidth than UUNet has, according to Schaeffer.

"Now is the time of evolution, not revolution," he said.

— End