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A growing number of small cities offer high-speed Internet access, but does local government belong in the telecom business?

Phil Davies - Staff Writer

Published November 1, 2004  |  November 2004 issue

Windom markets itself as a community "at the crossroads of opportunity in Southwest Minnesota." Two major highways converge in the town of 4,500, the seat of Cottonwood County and home to a Toro lawnmower and snowblower plant.

But four years ago city leaders and businesses felt that when it came to high-speed Internet access, Windom was stuck at the end of a dusty country lane. Qwest Communications, the incumbent telephone company, didn't seem interested in providing digital subscriber line (DSL) service, despite repeated entreaties from city officials and businesses. The only gateway to the Internet was dial-up service, at 56 Kbps (kilobits per second) far slower than DSL.

"I think it was obvious that [Qwest] did not want to invest that kind of capital in greater Minnesota; whereas, they had no objection to putting it in a new subdivision in Eden Prairie [a Twin Cities suburb]," said Windom City Administrator Dennis Nelson.

Today the city doesn't need Qwest or any other private broadband provider. In May the city issued $9.4 million in revenue bonds to fund a fiber-to-the-premises (FTTP) network that paves a wide data highway from the Internet directly into local homes and businesses. The state-of-the-art system, slated to start up next March, will also include digital phone calls and high-definition TV.

Years of frustration, not the prospect of financial gain, prompted Windom to get into the telecom business, Nelson said. Before authorizing construction, the city council held two voter referendums and spent more than $150,000 on feasibility studies—steps that he said would have been unnecessary if viable commercial broadband had been available. "The fact that the private sector was not coming to the plate forced our hand, to a degree," he said.

Windom's fiber network is just one of more than a dozen municipal broadband systems operating, under construction or proposed in the district. In the past five years other small, isolated cities such as Gladstone in Michigan's Upper Peninsula, Beresford, S.D., and Alexandria, Owatonna and Barnesville in Minnesota have gone into the broadband business, selling high-speed Internet connectivity through nonprofit public utilities. Not just a rural phenomenon, municipal broadband has also taken root in exurbs such as Buffalo and Chaska near Minneapolis.

These systems fit into a nationwide, steadily growing grid of telecommunications utilities, a high-tech extension of electricity, gas, water and other basic services offered by about 2,000 cities across the country. In 2002, 128 public utilities offered some kind of broadband connectivity, according to the American Public Power Association (APPA), a Washington, D.C.-based organization that represents municipal utilities. That's a 12 percent increase over the previous year. Big, highly publicized systems include the Click! Network, an arm of Tacoma Power in Washington state that offers broadband Internet access to nearly 23,000 cable TV subscribers, and Utopia, an ambitious direct-fiber project being developed by 11 Utah cities at a cost of more than $85 million.

Across the country and in the district, municipal systems span the full array of broadband technologies available today: DSL, cable modem, fiber to the premises (also called fiber to the home), fixed wireless and mesh Wi-Fi. Some public utilities provide just high-speed Internet access. Others, like Windom's, "bundle" broadband with other communication services such as cable TV, video on demand and dial-tone phone.

There's no question that businesses and residents in publicly wired towns have benefited from access to reliable, relatively cheap broadband. It's also possible, although difficult to prove, that municipal broadband has spurred economic development in nonmetro areas by serving both homegrown and transplanted businesses that otherwise would have chosen to locate elsewhere.

But increasing competition from the private sector, even in previously underserved rural areas, clouds the future of municipal broadband. Muni systems still have to demonstrate that they can effectively compete with private companies for high-speed subscribers in thinly populated areas. And ventures like Windom's FTTP network raise the larger, public policy question of whether local government should be in the telecommunications business at all. Vocal opponents of municipal systems—primarily, cable operators and telephone companies—argue that municipalities have no business dabbling in a market that is already being served by private industry.

A thirst for speed

For cities, taking the plunge into broadband seems a logical extension of what public utilities have done for a century or more—provide essential services such as electricity, water and sewage disposal. City officials and business leaders in small towns and exurbs have come to believe that their communities will wither without a fat data pipe to the outside world. Broadband is seen as particularly indispensable for Main Street companies looking to engage in e-commerce, tighten supply chains and efficiently link far-flung facilities.

Rather than risk being left on the weedy verge of the information superhighway, small cities have installed their own broadband systems, in many cases expanding upon existing high-speed networks used by utilities to monitor automated electricity and water systems.

"The reason cities get into this is not because they want to," said Andy Brewer, senior government-relations representative for the Minnesota Municipal Utilities Association (MMUA), which represents over 150 municipal utilities in the state. "It's a matter of providing needed services to the citizens of your city. If somebody else is not going to do it, or do it adequately, or do it with an economic model that the citizens can afford, somebody else has to do it."

Public utilities in Alexandria and Buffalo launched broadband services a few years ago because high-speed Internet was simply unavailable, unless a subscriber was willing to pay hundreds of dollars a month for a dedicated T-1 line. In the northern resort town of Alexandria, residents and businesses had trouble getting even dial-up access in 1996. Neither cable company Charter Communications nor telephone incumbent Sprint provided Internet access. Then Alexandria Light and Power (ALP), the city's 115-year old utility, began selling dial-up Internet access in partnership with Runestone Electric Association, a private cooperative in the area. "We entered into this venture because our citizens were not being served," said ALP Manager Al Crowser.

In 2000 the utility branched out into direct fiber, connecting government facilities, schools, hospitals and major businesses to a high-speed Internet backbone. Today about 45 Alexandria companies tap directly into the fiber network, including Tastefully Simple, a nationwide marketer of gourmet foods. ALP and Runestone Electric also operate two wireless systems, one geared to businesses and another oriented to residential customers.

The city of Buffalo launched its own $1.1 million wireless network in 2001. At the time Qwest offered only dial-up access on the Twin Cities' northwest fringes, and Charter expressed no interest in serving the city, said City Administrator Merton Auger. Today the Buffalo Wireless Internet Group (BWIG) has more than 740 customers, including about 100 businesses paying $40 per month for 384 Kbps service.

Get your broadband here

But in 2004 it's harder to make the case that without municipal broadband, rural communities would languish in dial-up oblivion. Recent studies show high market penetration in the district by private broadband vendors, even in small towns. In Minnesota, 85 percent of rural communities have some type of broadband access, according to a study released in April by the Center for Rural Policy and Development in St. Peter. A 2003 survey by the National Exchange Carrier Association found that over 85 percent of local access lines in Wisconsin were equipped for DSL. In North Dakota that figure was almost 92 percent.

Broadband adoption rates in rural areas are much lower; in the Center for Rural Policy study only 34 percent of Internet users who go online through a telephone line chose DSL instead of dial-up. "If you want to say what's holding back broadband adoption in rural areas, your number one reason is not lack of availability," said Center President Jack Geller.

One explanation for low "take rates" in rural areas may be high broadband prices relative to per capita income. The Center's study found that median prices for cable modem, DSL and wireless services in Greater Minnesota were higher than in the Twin Cities, despite the fact that household income outside the metro averages about 40 percent lower.

Yet the presence of private companies willing to bear the risk of offering rural consumers an alternative to dial-up access hasn't deterred several cities in the district from forging ahead with their own broadband systems. Availability isn't the only issue, overseers of these systems say; dissatisfied with the price and/or quality of commercial high-speed Internet access, they believe that they can do better.

Southwest Wireless Net, a fixed-wireless service owned by a farmer cooperative, has offered 512 Kbps Internet access in Windom since 2001. But Nelson said that the city considers the service inadequate because buildings, trees and other obstructions interfere with the signal.

Brian Horst, Gladstone city manager, was a prime mover behind that city's year-old fixed-wireless system. He said it covers more ground at higher reliable speeds than competing services from Charter Communications and Delcomp/SOF-TEK, a mesh wireless company in nearby Escanaba. Signals beamed from two towers in Gladstone and Escanaba reach businesses in outlying areas, including a small company that markets log-cabin kits online. "This was their first and only option for high-speed service, and they took advantage of it," he said.

In Chaska, a mesh Wi-Fi network that was slated to begin operating in September also covers the city like a blanket, overlaying existing commercial cable and DSL service. The difference is the price: Basic consumer service on the $750,000 network costs $16 a month, less than half the rates charged by Time Warner Cable and Sprint.

Bradley Mayer, information systems manager for Chaska.net, says that the city wanted to offer broadband that even low-income residents, including a sizable Latino community, could afford. "We realize that there's probably a good majority of our population that simply can't afford to pay the outrageous cost that you have to pay to get cable or DSL service in town," he said.

How can the city sell broadband for $16 a month? Mayer says that mesh Wi-Fi is much cheaper to deploy than either cable or DSL, and Chaska.net isn't out to make a substantial profit—only enough money to repay its capital costs within three years and invest in future enhancements.

Whatever the putative benefits these muni systems confer on local businesses and consumers, they're in head-to-head competition with private companies in a dynamic, rapidly growing industry. "Generally most municipalities don't have [broadband and other telecom] services, and have no desire to because there's a private provider who's doing a fine job," Geller said. In the last four years wireless providers such as Southwest Wireless, Midwest Wireless of Mankato, Minn., Duluth-based Superior Broadband, and Edge Networks of Seattle have brought broadband to hamlets and the open countryside beyond the reach of DSL or cable.

Even in cities bereft of broadband before city hall came to the rescue, private firms now offer an alternative to high-speed muni access. Sprint has sold DSL in Alexandria since 2002. In Buffalo, Charter introduced cable modem service in 2001, and Qwest rolled out DSL last year.

It's fair to ask what public utilities are doing peddling broadband in an active, increasingly competitive marketplace. Long-term viability is an issue for municipal broadband, given the tough economics of broadband deployment in the hinterland. And it can be argued, as opponents of municipal systems do, that private firms provide telecommunications services more efficiently.

"We think that if you're in a community that has private [companies] making the investment and has the service available, particularly from multiple providers, there's just no good purpose and role for government to be competing against them," said Chris LaRowe, manager of external affairs for the Wisconsin State Telecommunications Association, a trade group for telephone carriers, wireless firms and Internet service providers in the state.

Jammed signals

Nationally, broadband providers are finally achieving significant market penetration after years of wooing consumers apparently quite content with dial-up. In July, 51 percent of home Internet users had high-speed connections, a 13-point increase over the previous summer, according to Nielsen/Net Ratings, an Internet audience research firm. But signing up customers—and making money at it—remains a challenge in rural areas. Low population densities and a limited number of bandwidth-hungry businesses in small towns make it difficult for high-speed vendors to recoup their investment in fiber-optic cable, DSL nodes and radio gear. LaRowe said that the 80-odd incumbent telephone carriers in his organization aren't making much money on DSL.

Cities launching broadband systems make projections for subscriber growth—Windom estimates that it will break even by 2008, with about 900 broadband subscribers—but those projections may fall victim to low take rates and stiff private competition. In Buffalo, BWIG's subscriber growth has slowed markedly under pressure from Charter and Qwest, both of which aggressively market discounted introductory rates. In September the utility was considering cutting its prices and throttling up its access speed in order to compete.

The Progress & Freedom Foundation, a conservative think tank based in Washington, D.C., has lambasted city-run telecom utilities, portraying them as doomed enterprises unable to compete on a level playing field with commercial vendors. A 2004 PFF paper analyzes the balance sheets of municipal broadband systems in Bristol, Va., Kutzdown, Pa., and Ashland, Ore., finding in each case that the system doesn't meet its operating expenses.

"The most obvious problem with these things is that they are money losers," said Thomas Lenard, vice president of research at PFF and author of the 2004 study. "I've yet to come across one of these telecom entities that is actually covering its costs." He argues that residents and businesses would be better off without city-sponsored broadband, cable TV or phone service; freed from a financial albatross, they would pay lower electricity or tax rates.

Champions of muni broadband such as the APPA counter that Lenard's study and earlier critiques by PFF and other organizations are flawed, cooking selected data to serve the anti-muni agenda of telcos and cable firms.

Figuring out who's right in this debate is difficult, given the subtleties of municipal accounting. Stated operating costs may or may not include debt service and depreciation on equipment, for example. And although utility managers claim that their broadband operations support themselves, sans tax revenue or cross-subsidies, some costs (such as labor and previous investments in fiber backbones) may be absorbed by the city.

Established broadband munis in the district appear to be holding their own in the battle for subscribers and positive cash flow. Last summer BWIG was running an operating surplus of $7,700 a month, which Auger said the city plans to invest in a new "nomadic wireless" system that will allow subscribers to surf the Web from their cars.

Gladstone Wireless had 43 customers in September, Horst said-two shy of the point at which the system covers operating costs such as fiber leasing and tech support and begins to repay the city's initial capital investment of $82,000, borrowed from its electric fund. Crowser of ALP wouldn't divulge the utility's margins, but said that its dial-up, fiber and wireless services were operating in the black.

Public good or unfair competition?

Muni critics also accuse local government of wielding an unfair advantage in the marketplace, through access to tax-exempt bonds and ownership of critical infrastructure such as rights of way, utility poles and water towers. Such an "artificial" edge distorts the market for an essentially private good, Lenard of PFF argued, discouraging commercial firms from making the investment necessary to bring high-speed Internet access to outlying areas.

Public utilities retort that by leveraging their tax-exempt status and prior investments in infrastructure, cities are simply exercising their comparative advantage in a free market. And rather than discouraging private investment, municipal entry—or the threat of it—lights a fire under complacent private vendors. Nelson suggested that Windom's decision to build an FTTP network was the impetus for Qwest's rollout of DSL in the city a year ago. "I find it ironic that our city council in August 2003 made the decision to move forward, and a week later Qwest announced that they were going to start offering DSL service in Minnesota," he said.

The notion that local government shouldn't compete with the private sector in telecom is the basis of laws in about a dozen states that ban or restrict market entry by municipalities. A Wisconsin law enacted last spring bars cities from using tax revenues to construct or operate telecommunications facilities in areas where private firms already provide service, and mandates a three-year cost study and public hearings. The measure, passed after strenuous lobbying by telcos and cable firms, complicates any future expansion of broadband systems operated by several Wisconsin cities outside the district, including Waupaca, and Sun Prairie near Madison.

A long-standing Minnesota statute requires cities that want to sell regular phone service to win a 65 percent majority in a voter referendum. The law doesn't apply to cities that offer only Internet access, but it obliged Windom, which wanted to route local phone calls over its FTTP network, to hold referendums before moving ahead. Voters approved the system on the second try, in 2000. The statute hampers the ability of municipal utilities to broaden their market appeal by bundling phone service with their broadband offerings, perhaps in partnership with private firms. The MMUA has lobbied unsuccessfully to change the law for years.

In case of market failure, call ...

Considering the legal roadblocks erected in some states (state law doesn't yet restrict government entry into telecom markets in Montana, Michigan or the Dakotas) and deepening penetration into nonmetro areas by private firms, the best long-term prospects for municipal broadband may lie in tiny, remote communities that are in danger of being permanently bypassed by the Internet revolution. Broadband coverage in the district remains a patchwork quilt of high-speed technologies, shot through with holes where only dial-up is available. In the Center for Rural Policy and Development's broadband study, 15 percent of Minnesota communities had no broadband access, and that figure doesn't include unincorporated areas where one in five Minnesotans lives.

The Center's Geller suspects that the market has failed in those areas, limiting residents and businesses to dial-up until a better, cheaper technology comes along. "I don't see a lot of providers clawing over each other's backs competitively to serve 300 or 400 people in some very rural location in Minnesota," he said. So in such places municipal utilities may fill a niche as the high-speed provider of last resort. Wisconsin's anti-muni law, in fact, allows local governments to roll out broadband systems without restriction if no commercial provider promises to begin service within nine months.

Emerging broadband over power lines (BPL) technology, which transmits data packets down electrical wires, would make municipal utilities a natural fit for deployments in sparsely populated areas of the district. After all, power lines run just about everywhere, thanks to the determination of city-owned utilities a century ago not to be left behind by a hot new technology. The city of Rochester, Minn., is piloting a BPL system with 10 customers, including a church and cyber café. If technical and market tests go smoothly, the city's public utility would lease bandwidth on its power lines to Hiawatha Broadband Communications, an ISP and cable firm in Winona.

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