4G LTE offers facility based carriers great opportunities for recurring profits from build-out of network capacity for wireless carriers, but it also carries risk of lost profits. What are the key risks to consider in a network pricing model?
Wireless carriers are busy launching 4G Long-Term Evolution (LTE) services in tier 2 and 3 markets. Thousands of new cell towers are being turned up as a preparation for 4G LTE launch into small markets to accommodate the needs for the ever growing smart phone users. At the start, each cell tower typically requires 50M-200M of Ethernet backhaul to support the 4G LTE network infrastructure. While great opportunity awaits those facility-based carriers willing to build an Ethernet backhaul to tier 2 and 3 markets, they must also be aware of potential land mines.
There are numerous facility-based carriers eager to build Fiber to the Tower (FttT) and provide an Ethernet backhaul to the wireless providers at a competitive price with a promise of turning up the network promptly. Winning new business by setting very aggressive pricing for circuit build-out on a schedule with unrealistic completion dates not only risks eroding future profit margins, it also risks customer dissatisfaction if the network launch is late. A facility-based carrier should capture a realistic forecast of direct and indirect cost in a network pricing model to ensure a target profit margin can be maintained over the life of circuit. There are three key risks which should also be considered.
Network Pricing Model Risk Considerations
Although it’s tempting to keep the pricing low to win a contract, the facility-based network providers are in the business to make a profit. Providing an Ethernet backhaul to tier 2 and 3 markets requires extensive aerial and under-ground fiber builds. Here are three key risks to consider in your network pricing model.
1) A risk of exceeding the initial capital budget as so many uncertainties lay ahead with constructing networks including:
- Easements/permits – The longer the distance for an aerial and underground network build, the more likely that a facility-based carrier will negotiate with a large number of property owners. The carrier will also need to obtain multiple permits for rail road encroachment and crossing, bridge crossing, county and town permit, etc. Some property owners fail to respond to the carrier’s request for easement negotiations while others demand payments that exceed a budget amount. Also, a city engineer may request that the carrier re-design its route due to number of reasons during the permit approval. Additionally, potential easement and permit issues grow if the carrier requires an extensive construction to build its network to remote markets.
- Make ready – A poll attachment application, engineering, and implementation adds many months to network service delivery. Re-designing an aerial route to avoid project delay adds cost. A build that requires negotiations with multiple pole owners and extensive pole attachment requirements provides many opportunities for delay and added cost.
- IRU and leased circuit – It is often necessary to purchase an IRU or lease a dark- fiber and lit circuit to provide end-to-end services for wireless carriers as construction may not be feasible for all network segments. If an adjusted plan is to utilize an IRU or leased circuit, the facility-based carrier needs to deploy additional resources to negotiate carrier contracts. A monthly circuit cost will also incur during the term of circuit use that was not anticipated in the original plan.
- Construction protocol – A construction crew sometimes fails to follow a proper construction protocol. Many things can go wrong like digging the wrong side of the street, damaging underground pipes and cables, etc. These incidents result in dispatching a construction inspector several times to ensure the quality of construction jobs. Improper construction standard will also result in a higher risk of network outages once the circuit is delivered to a wireless carrier.
- Nature – Fiber cable damage can be caused by animals (squirrels/rodents chewing up fiber cables) and/or bad whether (trees falling down the aerial cables). A longer aerial route is more likely to have fiber cables damaged by Act of God (or animals), which must be repaired adding cost to the business.
- Dispatching technicians – Technicians may need to be dispatched multiple times due to missing parts, locked building entrance, etc. A projected one time visit may end up with multiple visits, which increases the cost of turning up services as well as the cost of future maintenance. Because of the remote locations of these cell sites, the average costs of dispatching technicians will be higher than in metro markets.
2) A risk of under allocating non-direct expenses. This can include such expenses as carrier management, legal, and operation to an Ethernet backhaul project in tier 2 and 3 markets as many carriers only apply a standard formula to allocate the non-direct overhead costs. A higher allocation of non-direct costs should also be considered for a project in tier 2 and 3 markets as more non-direct resources will be required to negotiate agreements and maintain the network during a life of circuits. Failure to allocate a higher non-direct cost to tier 2 and 3 markets in your network pricing model could result in a loss of competitiveness in tier 1 markets because tier 2 and 3 markets may be subsidized by the tier 1 market. Understanding this non-direct cost allocation mechanism, a wireless carrier may choose to purchase its network in tier 2 and 3 markets only making it possible for a strong competitor to reduce the company’s customer base in the tier 1 market.
3) A risk of early termination. In addition to the risks associated with network builds, the facility based providers also need to estimate the risk of early termination by a wireless provider in their network pricing model. A wireless carrier may choose to terminate service due to three main reasons. 1) Other carriers build competing networks and a wireless carrier has an opportunity to reduce its monthly network charges. 2) A wireless carrier decides to build a network rather than leasing to gain a better asset control and reduce overall network expenses. 3) Poor facility-based carrier performance, resulting in the wireless carrier terminating the network provider. In any of these cases, early termination penalties are typically structured based on a fraction of monthly circuit charges times months remaining. Because a rate structure of circuit termination generally is in favor of a wireless carrier to terminating services earlier than the contract term and pursues other solutions, there is no guarantee that the facility-based carrier will collect total revenue amount under the term.
Although it’s tempting to provide a competitive price to win the business and keep out of competitors, low cost strategies do not make sense if the action results in negative cash flow. In order to develop a realistic cost assumption, it’s very important for a facility-based carrier to build and utilize a network pricing model that compares baseline cost assumptions against the actual costs of projects. This approach allows the opportunity to recalibrate the baseline for future projects. My experiences show that when there’s a large construction project with extensive builds, more issues must be addressed that lead to additional capital requirements in order to complete the project. As a result, a higher risk premium should be added to the network pricing model to ensure that the target profit margin can be protected from unexpected events.
Every facility-based carrier should invest resources to identify an accurate cost of building networks to tier 2 and 3 markets. NetStrategy Solutions, has extensive experience developing network pricing models to ensure every telecommunications carrier stays profitable.