Ok kids. Gather around. Today’s lesson is engineering economics. How do you put together a business case for expanding broadband into a previously unserved area?
Putting together a business case is an important life skill. You can apply these kinds of studies to personal purchase decisions, or putting together a business case to launch a new service or discontinue an old one. And most importantly, it will help you understand better how to analyse discussions about rural broadband.
Let’s look at a business plan to expand broadband service into a certain area. For the sake of simplicity, we’ll start with an assumption that there are sufficient investment funds available to fund all the construction into unserved areas, subject to a condition that the investor is able to get a certain return on their investment.
Based on that constraint – a positive return on investment, the engineering department should be able to define an area that qualifies for construction. Their calculations would be based on a variety of assumptions: Capital cost of equipment and construction; annual operating expenses including maintenance; retail market share (and thereby retail revenue); wholesale market share (and wholesale revenue); taxes, etc.
All these numbers go into a spreadsheet and the engineer can keep adding more homes to the construction plan as long as the business case continues to be positive.
At some point in the exercise, the next incremental home has a negative impact on the business plan. The engineer can then draw a line on a map delineating a boundary.
That boundary effectively defines the digital divide: where the economics are unable to support traditional investment in infrastructure. On one side of the boundary, the more urban side, the private sector can line up investors willing to support broadband expansion.
On the other side of the boundary, the more rural side, a different approach is required. These households are candidates for government rural subsidy programs.
But let’s go back and look at the ‘urban’ side of the boundary line. That boundary is defined as precisely where the business case goes from positive to negative. Homes on the boundary effectively have a net present value (NPV) of revenues less costs of zero.
What happens if the revenue assumption changes? If revenues somehow increase, the boundary gets pushed outward. More homes (on the ‘rural’ side of the boundary) would potentially now have a positive business case. On the other hand, if revenues somehow decreased, the boundary gets pushed in the other direction and the business case is no longer positive for as many homes.
When the CRTC sets wholesale rates, it is implicitly setting the wholesale revenues for our mythical engineer’s business case calculations. The CRTC doesn’t impact the capital costs, they don’t change the retail rates, or even the market share assumptions. But, the regulated wholesale rates are what drives the wholesale revenue line in the business case. Drop the rates, wholesale revenues go down and total revenues for that area go down.
When the facilities-based carriers warn that changes to wholesale rates impact the incentives to invest in rural broadband, this is what they are talking about. These aren’t threats; it’s just basic economics.
Now you do, too.